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The important role of consumer credit in the economy

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Many factors have influenced the growing growth of consumer loans, but the inability of people to pay their expenses with their income is the most important. Unlike in the past, where debt was often frowned upon, borrowing money is now perfectly normal. People take out loans to buy a house or pay for school, travel or home improvement costs.

But alongside that, through banks and alternative lenders, the government is using loans to control the country’s economy. Because while loans offer consumers the opportunity to create lasting assets and significant expenses, at the same time, they improve economic well-being.

You might be surprised to learn that economic progress has been linked to the expansion of credit markets. To better understand this, we have discussed below the important role of consumer loans in the economy.

What are consumer loans?

There are different types of financing, and defining consumer credit is the first step in better understanding why and how they play such a vital role in the economy. A consumer loan is a loan or line of credit focused specifically on individual and household consumers. This means that the loan is intended for individual or family purposes.

Consumer loans can take many forms such as car loans, credit cards, student loans, or personal loans. You can use each to finance the purchase of a vehicle, daily expenses, education, or other personal purposes. With consumer loans, many people can finance their lives in different ways.

The relationship between consumer loans and the economy

Due to a persistent shortage of money, consumers are turning to loans to meet their personal and basic needs. It is no wonder that the amount owed by consumers increases with statistics. In the United States alone, consumer debt to finance household consumption climbed $ 87 billion in the third quarter of 2020.

It should be noted that debt is growing rapidly not only in the United States, but also in many developing countries. Because as income inequality and the trade deficit continue to grow, so too does the level of debt to avoid the economic slowdown and rising unemployment.

In addition, gross domestic product (GDP) is used as an indicator of economic production and one of its components is consumer spending. Thus, an increase in consumer spending directly leads to an increase in GDP. This is why consumer loans contribute significantly to economic growth as they allow people to buy more than their cash income.

The role of consumer loans in the economy

The link between consumer loans and economic growth is obvious. But to better understand it, take a look at the specific roles of consumer loans and why the government uses them to control the country’s economy.

Loans as an economic stabilizer

In each country, the government takes the initiative to help the economy achieve its goals of growth, full employment and price stability. In the United States, one of the approaches used by the government to influence economic activity is monetary policy. Through the Federal Reserve System, it uses its power to regulate money, supply and the level of interest rates.

When inflation occurs, the prices of goods and services will rise, leading to a decrease in the purchasing power of consumers. To control such situations, the government increases interest rates and decreases the money supply. Since money is tighter, the demand for goods and services will decrease with prices.

Deflation is the opposite and often signals an impending recession. To counter a recession, the government cuts interest rates and increases the money supply. Because it is cheaper to borrow money, consumers take more loans and buy more goods and services.

In both directions, loans play an important role in stabilizing the economy and tackling the threat of recession. But the effects of the loans do more than that. In the following, we have highlighted the implications of lending in the economy as investment debt and consumer debt.

Loans as consumer debt

Consumer debt includes loans that are used to finance personal or household consumption. Although it cannot grow debt money, it plays a relatively important role in promoting better economic performance.

Because households often use loans to smooth their consumer spending, GDP continues to grow and leaves room for more credit opportunities. Ultimately, this consumer spending accumulates with the investments and public spending that will lead to new economic growth.

Loans as investment debt

As consumers borrow more money and spend more, businesses must increase production to meet demand. When they are not in a position to finance such operations, they will opt for loans to sustain their activity. Thus, the returns on investment debt that will result in the production of their goods and services, which in turn contribute to the economy.

To take with

Loans are essential to help finance the needs and goals of consumers. And on top of that, it allows the economy to grow and benefits every individual in return. Through economic growth, consumers could improve their standard of living.

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