[HSC] Economist: 21 — 27 August 2017
The week in review.

This week’s article is inspired by Monday night’s Four Corners show, which examined the state of housing in Australia. The housing market has been repeatedly described by the media as being in a bubble and this is a result of a number of favourable government policies, including negative gearing. A shock to the economy in the form of a spike in unemployment or rising interest rates could cause the bubble to burst and if it does there could be wide-ranging consequences, namely lower economic growth, higher unemployment and a greater budget deficit! The GFC in America started in similar circumstances, where a credit crunch pushed up interest rates rapidly and caused many households to default on their mortgages.
Required Readings
- Soaring house prices are a result of accommodative government policies and intergenerational inequity.
- Australia has the second highest level of household debt in the world, leaving the housing market vulnerable to mortgage stress and the economy susceptible to a downturn.
- A decline in housing prices could have severe flow-on effects for the rest of the economy, particularly economic growth, unemployment and financial stability.
1. The Housing Bubble

The issue of house prices, particularly in Sydney and Melbourne, has been ever present over the last couple of years. Those two cities saw growth of 16.7% and 15.1% respectively in 2016, according to NAB. As explained by Ross Gittins, there are two main motives for purchasing a house. Firstly, there is the belief in the Australian Dream of home ownership and the autonomy that goes with it. However, this motivation has always existed so cannot on its own, explain the recent uptick in prices. The second driving factor is individuals viewing property as a fruitful investment opportunity due to the array of accommodative policies in place.
Negative gearing allows individuals to reduce the financial loss associated with property investment. When the costs linked to the investment property, predominantly mortgage repayments, exceed the revenue generated by the investment property through rental incomes, the investor is allowed to deduct those costs from their taxable income. Capital gains tax exemptions for the family home also add to demand. Government policies designed to rectify this issue, such as the First Home Owner Grant, have only served to worsen the problem by increasing first home buyer’s ability to afford inflated prices. The result of all of this is demand for housing outstripping supply causing prices to rise rapidly.
In order to purchase a house the vast majority of individuals require credit, i.e. a mortgage. Historically low interest rates are enhancing individuals’ tolerance of debt and as a result, household debt has risen to extraordinary levels.

The level of household debt has now reached 190% of household disposable income, which has caused some to speculate about the likelihood of a housing crash. Any crash would require a trigger, some sort of contractionary shock. However, with 820, 000 households already facing mortgage stress, i.e. having difficulty meeting repayment requirements, that shock may not need to be particularly large to have a drastic impact upon the Australian economy.
There are two main circumstances that would cause further mortgage stress and could trigger a crash. Firstly, a significant rise in unemployment would see household incomes drop, inhibiting their ability to meet debt obligations. However, unemployment is trending downwards and looks unlikely to increase significantly in the near future. The second threat borrowers face is an increase in interest rates. The cash rate is currently at 1.5%, a historically low level and approximately 4% below the long-run average. An increase in the cash rate would raise repayment costs and mortgage industry expert Martin North has projected the changes in mortgage stress associated with different movements in the cash rate.
A 50 basis-point rise in the cash rate to 2.0% would result in more than one million households experiencing mortgage stress, whilst a return to the long-run average of 5.5% would lead to over two million households facing mortgage stress. Increases in the rates of mortgage stress have major implications for the rest of the economy.

For consumers, the first place where the effects of a housing crash would appear would be in reduced consumption levels. Greater expenditure on mortgage repayments would leave a smaller slice of the income pie for consumption. This would quickly lead to lower economic growth and in turn higher unemployment. A higher unemployment rate would worsen the issue further and potentially perpetuate a disastrous downward spiral.
For the banks, higher levels of mortgage stress would cause a higher incidence of borrowers defaulting on their loans. Given that mortgages constitute approximately 60% of the big banks’ lending, this would have an enourmous impact upon their stability and likely lead to further downgrading of their credit ratings, which were already downgraded by Moody’s earlier this year. The recent raising of mandatory capital ratios was done with the goal of minimising the potential for a financial shock to be transmitted to the rest of the economy and the changes are discussed here.
Poorer consumer outcomes and financial instability would worsen the government’s budget bottom line as taxation receipts fall and expenditure on transfer payments increases. This would prevent the government from achieving fiscal consolidation and returning the budget to surplus.
HSC Relevance
- Rapid house price growth in recent years has significantly contributed to the worsening of wealth inequality in Australia.
- Household debt has grown at a much faster rate than incomes and average household debt is now almost double annual household disposable income.
- Fiscal policy measures such as the Capital Gains Tax, Negative Gearing and the First Home Owner’s Grant have caused demand to exceed supply and accelerated housed price rises.
- Historically low interest rates have also encouraged an expansion in borrowing in order to purchase property.
- 820, 000 households face some level of mortgage stress currently and this looks likely to increase.
- The two factors most likely to cause a housing crash are a sudden jump in unemployment or a raising of the cash rate. However, regular readers will know that most economists do not forecast a rate rise within the next twelve months.
- If mortgage costs were to rise, they would cause consumption to decrease, which would lower aggregate demand. This would reduce economic growth in the short-term and increase unemployment because the demand for labour is derived from the demand for goods and services.
- If mortgage defaults rose, it may cause ratings agencies such as Moody’s to further downgrade the credit ratings of Australia’s banks, indicating instability.
- Any downturn in economic activity in Australia would worsen the budget outcome through the automatic stabilisers built in to the budget, which are designed to act counter-cyclically and smoothen fluctuations in the business cycle.
- High levels of household debt have been constantly mentioned in the RBA’s statements on monetary policy, which indicates their significant influence over contemporary monetary policy in Australia. The RBA is severely limited in it’s policy options; any rate rise would exacerbate mortgage stress, whilst any rate cut would likely increase household debt levels.
- Monetary policy is a blunt instrument and is thus unable to target specific sectors of the economy. This limits it’s ability to achieve objectives such as an equitable distribution of income.
- Any housing crash would have negative outcomes for the entire Australian economy, including consumers, businesses and government.
2. Elsewhere Around the Globe

- The British economy grew 1.7% in the 2016–17 financial year.
- Inflation in Japan remained steady and positive at 0.4% in July.
- US consumer sentiment rose by more than expected in August.
Further Reading
Impress your teachers with the following articles!
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