ECONOMIC ISSUES

Australia and the Household Debt Problem

Insights

What Has Happened?

Household debt has been a problem in Australia long before the COVID-19 recession as reflected in a household debt to GDP ratio of almost 200% in January of 2020. Initially, it was mostly catalysed by the catch-22 facilitated by the combination of low interest rates and rising house prices; the higher the prices climbed, the more households borrowed in order to purchase properties, which pushed demand and thus house prices even higher and then pushed further borrowing and so on.

 

However, there are fears that the presence of household debt will exacerbate the imminent COVID-19 recession and slow economic recovery, which has hence prompted major shifts in macroeconomic policy.

Syllabus Links

AD = C + I + G + (X-M)

High household debt decreases the capacity and willingness of households to spend which thus decreases consumption, production and economic growth. With respect to the aggregate demand function, AD = C + I + G + (X-M), there is a fall in the consumption component.

Further, climbing household debt being accompanied by slow wage growth, which has been present in the Australian economy for years, means that the blow to consumption is not cushioned by increases in wages.

The current situation has raised many concerns surrounding debt and its ability to act as a catalyst for potential instability in the Australian economy, an issue that is magnified in light of the imminent recession. It can be argued that household debt ‘threatens to worsen’ the recession for the same reason that initiated the global financial crisis; defaulting. The recent slashes to jobs has immensely reduced the capacity of households to pay back their loans, and thus increases the potential of default. Too many defaults at the same time has the potential to collapse or at least maim the banking sector. However, economists aren’t worried about an influx of defaults and therefore do not consider the outcome of the collapse of the big banks plausible, but rather, they are worried about what households will do to prevent defaulting; cut their spending back even further. The fall in consumption explored above  tends to occur even in more optimal economic climates is likely to be much deeper due to this urgency to avoid defaulting.

Falls in demand due to pressures of debt


It is expected that amidst the COVID-19 recession, the presence of immense household debt and its exacerbation of lower spending and thus demand for goods and services, would place a downward pressure on prices. This would generally result in an inflation rate lower than the rate that occurred in earlier and more comparatively optimal economic conditions. Considering the 2019 the inflation rate was already below the target range of 2-3%, the current rate should theoretically be quite low.

 

However, the implementation of quantitative easing in particular by the RBA, a policy which has been nicknamed ‘printing money’ but involves using its cash reserves to purchase mostly government but sometimes private bonds, is cushioning the downward pressure on the inflation rate, with the current rate actually within the target range at 2.2%. 

The fact that household debt amongst other factors, including the rise of unemployment, has narrowed the capacity of households to consume has moved the burden of catalysing economic recovery from households to the government and businesses. This is reflected in the fiscal stimulus of over $200 billion AUD implemented in April. The role of businesses to act alongside the government to push recovery is diminishing more than usual in an ordinary recession due to the pressure placed by lockdown restrictions that are only just beginning to ease. However, regardless of levels of household debt and even lockdown restrictions, this burden being carried by the government as per intensive expansionary fiscal policy is expected.

In addition, fiscal stimulus to support individuals who hold high levels of debt within the economy, has meant the government must incur higher debt levels. Here, private sector instability which has plagued Australian households is in effect being transferred into public sector instability.

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