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Issue Date: Mon 3-Jun-2019
Article Source: https://www.news.com.au/finance/real-estate/sydney-nsw/why-an-interestrate-cut-could-...

Why an interest-rate cut could boost consumer spending

A recent study by the RBA could pave the way for a cut in interest rates if the housing market continues to decline ' and this could mean a boost in household wealth.

WHEN our wealth increases, Australian households consume more. So the much anticipated cut in interest rates will be important in boosting consumer spending.

Economists suggest a recent study by the Reserve Bank of Australia paves the way for the RBA to consider lowering interest rates if the housing market continues to decline, despite its current official neutral stance.

An analysis of the “wealth effect” has been undertaken by the RBA which has studied just how households consume more when their wealth increases.

Household wealth is measured as the household sector’s assets minus its liabilities. Household assets comprise financial assets, which include bank deposits, share holdings and superannuation balances, and non-financial assets, which include housing and durable items such as motor vehicles.

A decrease in interest rates could fuel consumer confidence. Picture: Justin Lloyd.Source:News Corp Australia

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Household liabilities are largely made up of residential mortgages, plus credit card debt and personal loans.

The latest research has pinpointed a positive relationship between household wealth and consumption, but reaffirmed the recent view of the RBA governor Dr Philip Lowe who declared the wealth effects from declining housing prices were “relatively small.”

The results found that a one per cent increase in the value of equity or housing wealth leads to a 0.12 per cent to 0.16 per cent increase in the long-run level of our consumption.

The three researchers, Diego May, Gabriela Nodari and Daniel Rees found any decline in household wealth was less likely to coincide with weaker consumption growth if it occurs at a time when the labour market is strong and household income growth is firm.

The RBA could cut interest rates if the housing market continues to slump.Source:Getty Images

They noted over the past decade, Australian households’ wealth has changed significantly. Household wealth has grown much faster than household income over recent decades, largely because of increases in the value of household assets, which have grown from around six times household disposable income in the early 1990s to around eleven times currently. It also acknowledged household liabilities have also grown faster than household income, although by less than household assets.

During the global financial crisis, the value of household wealth declined, but then increased by around 60 per cent between 2013 and 2017. The growth in household wealth has slowed recently because of falling housing prices.

It noted a difference between movements in housing and share markets.

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Each state’s housing market is geographically distinct and affected by region-specific shocks as well as national macroeconomic fluctuations. By contrast, movements in stock market wealth were more synchronised across the states.

Their modelling estimation suggest a one dollar increase in stock market wealth raises annual consumption by about 15 cents, whereas a one dollar increase in housing wealth raises annual consumption by about 3 cents.

The RBA researches did some modelling on the impacts on consumption of a five-year slump in house prices of 10 per cent.

A decrease in interest rates could fuel consumer confidence.Source:Herald Sun

Despite a fall in house prices, many are seeing an increase in inspection numbers.Source:Supplied

The key finding was that reducing interest rates will soften the blow to any drop in overall consumption “without necessarily returning housing prices to their initial level”.

The results indicate that consumption can respond quickly to changes in housing wealth, so while cutting interest rates may not cause a rebound in house prices like the past, it will be critical for keeping the economy out of recession.

 



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