High home loans ‘hurt economy’

HEFTY home loans which have fuelled record levels of household debt have become a key burden on the economy, new research from the Reserve Bank of Australia has found.

Huge mortgages are holding back consumer spending – a key driver of the economy – which will remain subdued even if business conditions pick up, the research says.

Rising house prices and share markets also fail to encourage households with large mortgages to loosen their purse strings even when their budgets are not stretched, the research says.

This trend, dubbed a “debt overhang effect”, is largely unchanged throughout economic booms and busts.

The findings are contained in a new paper from the RBA’s economic research department that probes the relationship between owner-occupier mortgage debt and spending.

It lands as both the central bank and government unleash measures to stimulate a slowing economy and economists across the globe puzzle over why spending in many developed nations has remained subdued despite low unemployment and generally robust economic conditions.

The paper challenges the widely held economic theory that people spend based on what they think their longterm average income will be rather than their mix of debts and assets.

“We find evidence consistent with a debt overhang effect – households cut back on their spending when they have higher levels of outstanding mortgage debt,” it says.

“This overhang effect holds even when households’ net housing wealth remains constant, implying that households reduce their spending when the gross value of both their debt and assets increases.

“In other words, we find that a deepening of household balance sheets is associated with less household spending, even if it is not associated with rising net indebtedness.”

The paper said the debt overhang effect was “pervasive across owner-occupier households and not exclusively driven by households that are financially constrained or that have strong precautionary saving motives”.

“We find evidence that indebted households reduce their spending by more than other households during adverse macroeconomic shocks, such as the global financial crisis, but the negative effect of debt is also pervasive at other times,” it says.

The RBA has delivered back-to-back interest rate cuts while the federal government has pushed through $158 billion in income tax cuts.

The paper gives cautious support to the measures, saying “providing debt relief or easing financing constraints through lower interest rates or tax incentives may lift spending”.

It was written by RBA researchers Fiona Price, Benjamin Beckers and Gianni La Cava who drew on data from the “Household, Income and Labour Dynamics in Australia” survey from 2001 to 2017.

WE FIND EVIDENCE CONSISTENT WITH A DEBT OVERHANG EFFECT – HOUSEHOLDS CUT BACK ON THEIR SPENDING WHEN THEY HAVE HIGHER LEVELS OF OUTSTANDING MORTGAGE DEBT RBA RESEARCH PAPER