Posted in Finance, Accounting and Economics Terms, Total Reads: 319
Definition: Dear Money
When the money supply in the economy is tight and the interest rates are high it’s difficult for individuals and corporates to get loans from financial institution groups like banks, this is also known as dear money. It’s a period of restricted money supply. When this happens due to the demand supply imbalance for money the interest rates are pushed up and it becomes difficult for firms to raise capital or get loans. The expenditure of the firm is reduced because firms spend cautiously since money was borrowed at a higher rate of interest than usual. It is also called tight money
It’s a policy of the economy where government restricts the money supply in the market making it expensive to borrow by raising interest rates. This would have an adverse impact on growth in the economy because the investment would reduce when the rate of interest is high. This macro-economic phenomenon is also known as crowding out particularly driving out investments in a country.
If the nominal rate of interest is 12% and the inflation is 5%, the real rate of interest is (nominal r – inflation) 7%. If firms borrow funds at this rate of interest, then to make the investment worthwhile the companies should invest in projects whose rate of return is greater than 7%.
During this Dear money phase the bid-ask spread is low so they make a small return on each trade but they can profit from trading in large number of securities. This large volume of trade can add up the return to a significant amount. During tight market investor’s benefit from the volume of trade by earning small profit on each trade, trading is active and very competitive.
Policies during dear money reduces growth in an economy. Economy experiences low investment due to high interest rates. When there is no investment in technology and assets (capital) then economic growth is hampered. Economy which facilities creation of knowledge, innovation and entrepreneurship is sustainable for growth. The way corporates get their financing effects the investment made by them and the output produced. Monetary policies which effect this financing also effect the output generated. In India when Reserve Bank of India (RBI) adopts a dear money policy, the cost of money increases steadily.