Household debt levels soar

  • Opinion
  • July 13, 2016
  • Satish Ranchhod
Household debt levels soar
Image: Kerryn Smith

Since 2012, the amount of debt households are carrying has risen to levels equivalent to 162 percent of their annual disposable incomes.

That’s higher than the peaks reached prior to the financial crisis and has completely reversed the reduction in debt levels seen in preceding years.

Fuelling this increase in household debt is the current very low level of interest rates.

The Reserve Bank has cut the OCR to a record low to boost demand in the face of very low inflation and a barrage of significant economic headwinds, both domestically and offshore.

Low interest rates have boosted debt in two ways. The first is by making it less expensive for households to fund consumption spending using debt.

The second has been through higher asset prices. In particular, low interest rates have boosted the housing market, contributing to strong growth in house prices. In turn, this has boosted household wealth and encouraged household spending.

The resulting debt-funded increases in household spending and strengthening in the housing market are helping to offset some of the weakness in other parts of the economy, particularly the dairying sector. Furthermore, with the OCR likely to remain low for some time, continued increases in debt levels are likely.

Some increase in debt levels in response to low interest rates isn’t necessarily a problem. In fact, with low interest rates encouraging borrowing, this indicates that one of the key channels that monetary policy uses to influence the economy is operating as expected. In addition, the low level of interest rates means that the proportion of household incomes spent on debt servicing has actually remained low.

However, the increase in debt levels still raises important concerns for the economy over the coming years. Most notably, households will eventually need to repay debt. And larger increases in debt now will require larger reductions in spending in the future. This will be a drag on growth over the coming years.

In addition, higher debt levels mean the economy is more vulnerable to unfavourable developments in economic or financial conditions – including possible future increases in interest rates, as households have less of a buffer from changes in economic conditions.

For the RBNZ, these conditions will require a delicate balancing act between its monetary policy and macroprudential aims. These two sets of policies are interconnected, but at times their goals can conflict with each other. This is one of those times.

In terms of monetary policy, the RBNZ is bound to keep the OCR at low levels due to the weakness in inflation. However, this will inevitably lead to higher asset prices and debt levels, which adds to the risk for financial stability. Consequently, we’re unlikely to see any easing in macroprudential settings anytime soon. In fact, there is a risk that we could see some tightening in macroprudential settings over the coming years, which would make the task of raising inflation back to two percent on a sustained basis more challenging.

This story originally appeared in NZRetail magazine issue 744 June / July 2016

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