This “balance sheet” approach to looking at households reflects long-term economic theories, including the permanent income hypothesis that was first developed by Milton Friedman in the late 1950s.
But the RBA’s Fiona Price, Benjamin Beckers and Gianni La Cava found that in Australia, the increase in debt over recent years was directly linked to the drop-off in household spending that has hit the broader economy.
They found a 10 per cent increase in debt could reduce household spending by 0.3 per cent.
While debt levels fell in the wake of the global financial crisis, they started to stabilise and then resumed climbing from late 2011, when house prices in Sydney and Melbourne started to lift.
At that point, Australian households held about $1.60 in debt for every dollar of income. By the end of March this year, that had climbed to a record high $1.90 of debt for every dollar of income.
The researchers found the reduction in spending by households, even as the value of their assets climbed, “directly violates” the permanent income hypothesis and went some way to explaining the economy’s torpor of recent years.
“Overall, the negative effect of debt on spending is pervasive across households with owner-occupier
mortgage debt,” the researchers said.
“Our results also suggest that an increase in aggregate owner-occupier mortgage debt can have
important implications for aggregate spending, all else constant, and go at least part of the way to
resolving the post-crisis “puzzle” of unusually weak household spending in Australia.
“While we find that household spending is more sensitive to debt during adverse shocks such as the GFC and local housing price shocks, the negative effect of debt also persists in more “normal” times.”
A key element of the federal government’s $158 billion tax package, refunds worth up to $1080 for low and middle income earners, start flowing on Friday with hopes it will boost consumer spending.
On top of recent cuts in official interest rates, some economists believe they will act in a similar way to the stimulus cheques mailed out by the Rudd government during the GFC.
On Thursday, RBA governor Philip Lowe held a two-hour meeting with Treasury officials and Treasurer Josh Frydenberg to discuss the state of the economy.
Mr Frydenberg said the pair agreed the economy’s fundamentals were sound, with the boost from the tax cuts and other areas yet to come.
“The combination of the tax cuts, the interest rate cuts, the infrastructure spending, the regulatory changes that APRA have made which are going to provide a boost to the housing market, as well as the pick-up in mining investment after a period of decline as the mining sector moved from the investment stage to the production phase, all of that is going to be good news for the Australian economy,” he said.
Australian Bureau of Statistics figures on Tuesday showed the headwinds facing the economy, with the value of home loans for owner-occupiers and investors issued in May falling by 2.4 per cent.
They have now fallen by 20.9 per cent over the past year, a steeper annual fall than recorded during the depths of the GFC.
Shane is a senior economics correspondent for The Age and The Sydney Morning Herald.