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Why household debt rattles the economy’s cage

Australia’s average level of household debt, relative to disposable income continues to punch out new records, moving up to 188.7% in March 2017. That level of debt is directly linked to house prices, which we know, on average, are growing like topsy, in an era when incomes are growing at a slower pace. For the economy, the real concern in housing markets is less that prices rise and more that households cannot afford to service the loans connected to them.

A housing price boom does not, in and of itself, make for a housing bubble. As Greg Jericho wrote in the Guardian:

“Now housing prices going up – or even booming – does not mean we are necessarily experiencing a bubble. A bubble occurs when the increase in price is at a rate that is unsustainable and is also out of whack with the reality of the situation.”

So what is it about housing prices that maybe unsustainable? The short answer is ‘debt’.

Again, as Jericho says, there are few of us who pay cash for a house. In general, we borrow, which increases our household debt. We have become particularly adept at growing our debt in Australia. That is why, on average, household indebtedness has hit that 188.7% of disposable income mark. The ratio, shown over time, is in the chart below.

fig 1

What is important to remember is that this is not a measure of how much actual debt households have, in dollar terms. The ratio in the chart shows that in 1990, the average level of debt was around one-third of what it is today, when compared with the average level of disposable income.

We can see that in around 2007, through to about 2011, Australia stabilized its average household debt to income ratio, riding out the GFC and waiting until interest rate cuts were absorbed into the economy before commencing the new debt splurge. While its true that the pace at which debt increased was not too dramatic, compared with earlier periods, it was building off a much higher base.

Never higher, Australian households find themselves with debt that is only sustainable under certain conditions. Like when real wages are growing in line with the rising debt. Or even, when house prices are stable and/or growing in line with rising income levels.

But the Australian economy has neither of those features right now.

Australian’s incomes are growing slowly, far more slowly than the average rate of growth in household indebtedness. Additionally, house price rises are not sustainably linked to increasing incomes. 

The saving grace for many – and perhaps for the economy – is that interest rates are low. That means that as house prices rise, the ratio of housing debt (that portion of household debt specifically related to housing) to asset value has declined. We can see this in the chart below, also produced by Greg Jericho.


This more pleasant chart shows that thanks to rising prices and low interest rates, Australians, on average, own a little bit more of their house than was previously the case. That is a good thing, and as Jericho puts it:

“…while it is good that asset prices are rising faster than we are accumulating debt, that ratio only works so long as the asset prices keep rising and interest rates stay low. It can get ugly quickly if house prices fall, or interest rates start going up.”

The rising stock of smaller apartment style dwellings is, if nothing else, likely to dampen further rises in prices. On 23rd April, UBS for instance, called the top of the market, suggesting a correction will be immediate but is not likely to lead to a dramatic crash.

In a widely reported analysis, UBS commented:

“Looking ahead price growth has likely now peaked, and we see a moderation ahead amid record supply and poor housing affordability.

“We are ‘calling the top’, but stick to our forecasts for commencements to ‘correct but not collapse’.”

Additionally, it has been widely reported that the banks have commenced increasing interest rates without reference to the RBA. 

If house prices fall, or even just stop growing, coupled with rising interest rates, household debt levels could move even higher. 

Are housing prices unsustainable? Perhaps and also, maybe not. But due to unprecedented levels of household debt, sections of the housing market maybe heading into unsustainable territory.


Posted Date: May 2, 2017

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