Background: How Real and Finance Are Related

§ March 14th, 2018 § Filed under Uncategorized Comments Off

 

Berlin – Real and finance are inextricably linked. Their distinction is merely a theoretical construct for the demarcation of money and goods flows. An example of the close connection between the two sectors is Volkswagen Bank – a financial institution whose main task is the financing of car purchases and thus supports VW production.

Image: House from banknotes

The real and financial sectors are linked above all by three links. On the one hand via the interest rate channel. Companies and private individuals borrow money to buy machines, refrigerators or real estate. Even states borrow money sometimes. These loans provide them the finance industry, which demands interest on them. However, if the sector is shaken by events such as the recent stock market turmoil or concern for public finances in the US and Europe, then the industry shies away from risk.

Banks then demand higher interest rates or restrict the granting of loans. This puts a strain on the economy, as companies and private individuals then forego investments or purchases because of higher loan hurdles. The resulting decline in demand can lead to rising unemployment and further negative consequences for the economy as a whole. An example of this is the financial crisis, which originated in the USA in 2007. The resulting credit crunch brought numerous companies to their knees and left millions unemployed. Politics was counteracting economic stimulus in many countries.

Sensitive relationship of trust

Secondly, the real and financial sectors are linked by a mood channel. Imbalances on the capital markets also influence the mood of consumers. The turmoil unsettles the people who tighten their belts out of concern for their money and keep their money together.

A blockade in the flow of credit is synonymous with a loss of confidence on the part of business, consumers and states. The financial sector is doing its job – the supply of capital – only insufficiently. Consumer confidence has recently been shattered to its foundations by the highly speculative business of the industry, which is seen as the catalyst for the crisis.

The third link is the wealth channel. Downtrend on the stock markets, which sometimes seem irrational, not only shake the financial sector, but also destroy assets.
In the past few days alone investors have lost several trillion euros because of the slide on the world’s stock exchanges. This restricts them in their investment opportunities and can thus also have a negative impact on the economy.

Experts puzzle over crash episodes

The impact of the current stock market turmoil on the real economy is difficult to predict from the point of view of the head of economics of the German Institute for Economic Research (DIW) Berlin, Ferdinand Fichtner. With regard to the destroyed assets, the losses on the stock markets have so far been painful, but still no drama, says the DIW expert. After the collapse of the US investment bank Lehman Brothers more money had been lost.

In his opinion, the strongest leverage effect could therefore unfold the uncertainty of the population on the economy. How people react to the stock market crash, is currently hardly estimate, says the scientist.

A more pessimistic attitude is represented by Fichtner colleague Axel Lindner from the Institute for Economic Research Halle (IWH). Negative effects would be felt in any case, possibly later this year, says the deputy head of the Department of Macroeconomics.

 
 

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