A Look at Rising Household Debt in Australia and the Implications for Policy

​​It is important to understand what is driving household debt and how it may evolve.


Australia’s economy is giving off mixed signals: Even as GDP growth and income slow, household debt appears to be rising. Understanding what is driving household behavior has important implications for policy and interest rates.

During Australia’s most recent economic upswing, national income outpaced output, but with larger-than-anticipated commodity price drops over the past year, this trend has reversed. This is apparent on a per capita basis, with net national disposable income actually falling, as seen in Figure 1. At the same time, the main macro variables of unemployment, private final demand, wages, inflation and confidence have all weakened. (For a discussion of how the Australian terms-of-trade cycle is now weighing on nominal growth and national incomes, see Australia Credit Perspectives, August 2014.)



The Reserve Bank of Australia (RBA) has tried to cushion these macro headwinds by lowering the cash rate to historically low levels but is now faced with the risk of over-stimulating the housing market. Indeed, common metrics of household leverage and house price valuations remain elevated in Australia, particularly compared with those in other developed markets (see Figure 2).



How household leverage evolves will have implications for policymakers and the potential path of interest rates. A positive response to leverage in the face of weakening fundamentals may increase the economy’s vulnerability to a more severe downturn. This complicates the RBA’s reaction function when setting policy by introducing financial stability risk. Therefore, it is important to understand what is driving household debt and how it may evolve.

The evolution of Australian household leverage
The run-up in debt at the household level was incurred during a very buoyant period when nominal growth and wages were high, as seen in Figure 3. From 2000–2008 debt relative to income accelerated from 80% to 130%, while nominal growth averaged nearly 8% and wages grew at 4% annually.



More recently, the end of the commodity cycle has resulted in a larger-than-expected negative income shock. In fact, over the past three years, nominal growth and wages have only averaged gains of around 3% per annum, with the trend continuing to fall. If this downward move persists over the medium term, as expected by the RBA, household expectations could start to deteriorate, leading to a slow but persistent need to decrease leverage. As a result, consumers could increase savings, and the response to low interest rates may be more subdued than history would suggest.

However, it is also possible that lower mortgage rates and asset price appreciation may drive a more irrational response relative to the macro fundamentals, a “herd mentality” that assumes continued capital price appreciation and creates the fear of “missing out.”

The role of debt
Households often decide to incur debt to finance assets that will provide a future expected payoff and maximize their net worth. Therefore, the level of debt incurred is typically tied to:


  • expected future capital gains in the asset
  • expected future income related to the productivity of the asset
  • debt-servicing costs


Should expectations rise for future capital price or income gains and/or should debt-servicing costs fall, households may increase their desired levels of debt. The problem is that expected future capital price gains may become unrealistic when extrapolated from recent history (“irrational exuberance”), leading to excess borrowing, which, when unwound, can lead to large negative externalities.

Rather than commenting on the appropriateness of any given debt level, we have focused on what is driving the change in debt metrics. Due to the importance of household debt ratios in consumption, which is ultimately what policymakers are concerned about, we use debt-to-income as our preferred measure of household leverage.

Australian housing in an international context
Given the importance of expected future capital gains in household behavior, it is worthwhile putting Australian house prices in an international context. Based on data from the OECD (2014), two commonly used valuation metrics place Australian house prices at the higher end of international comparisons, as seen in Figure 4. With this starting point, it seems questionable to embed expectations of continued high price growth.


Analyzing household behavior
In a recent speech (April 2015), RBA Governor Glenn Stevens touched on the vulnerabilities created by household leverage: “Household leverage starts from a high level… the extent to which further increases in leverage should be encouraged is not easily answered.“ He described dwelling prices as having “already risen considerably from their previous lows, at a time when income growth has been slowing,” adding that “it is hard to escape the conclusion that Sydney prices – up by a third since 2012 – look rather exuberant.” He also acknowledged the importance of financial stability issues: “The conduct of monetary policy can’t allow these financial considerations to dominate the ‘real economy’ ones completely, nor can it simply ignore them. A balance has to be found.”

Given the increased weight the RBA places on these vulnerabilities when setting monetary policy, analyzing what drives household debt is highly relevant.

To determine which factors drive household leverage, we statistically tested the response (the change) in household leverage against changes in several key variables including wages, unemployment, asset prices, confidence and the cost of credit.

We first tested the explanatory variables individually to see whether they are significant, and from that subset, we tested them together to see how they interacted and whether some variables dominate others. Importantly, we also tested various lags in these explanatory variables to proxy for expectations. That is to say, individuals’ expectations and responses may change under a persistent set of conditions. So, for example, a quarter of strong wage growth may not be sufficient to shift expectations, but over several quarters, strong wage growth may result in an increase in leverage as expectations for future income are revised higher. (An upcoming paper, “A Model of Australian Household Leverage,” will provide a detailed explanation of our methodology.)

The modelling results reveal that asset prices and mortgage rates largely explain the change in household leverage. These two factors appear to dominate all other variables regardless of how significant they are individually.

From this we infer several probable outcomes in Australia:


  • Households’ decision to incur debt is dominated by the cost of debt (the mortgage rate) and recent asset price appreciation, which may not be sustainable or linked to the productivity of the asset.

  • Of concern, households are exhibiting irrational exuberance because they are placing little weight on broader fundamentals like unemployment that may be more representative of future incomes or asset price returns, increasing the likelihood of asset price bubbles.

  • Australian households appear to respond rather quickly, needing only two quarters of favourable changes in asset prices and mortgage rates to increase leverage.

  • Australian households will react faster and more vigorously to a shock in asset prices or mortgage rates. This could result in a feedback loop where falling asset values induce further deleveraging.


Based on our model for household leverage alone, if an exogenous shock sparked a deleveraging cycle in Australia, it would be expected to be quite severe given the larger co-efficient for asset prices and the quicker household response. Clearly other factors not captured in the model may mitigate such a severe outcome, and no model is perfect, but as a starting point this statistically highlights the potential vulnerability of high and rising household leverage incurred on the basis of past asset price movements. We believe macro-prudential measures should be strengthened to address financial stability risk and give the RBA maximum flexibility when setting policy for the aggregate economy.

Finally, given the sensitivity of households to mortgage rates, the peak in the cash rate in the RBA’s next hiking cycle is likely to be much lower than in previous cycles. This is in accordance with PIMCO’s New Neutral view that calls for much lower policy rates for an extended period.

The Author

Aaditya Thakur

Portfolio Manager, Australia and Global

Laura Ryan

Quantitative Research Analyst, Client Analytics



Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517), PIMCO Europe, Ltd Amsterdam Branch (Company No. 24319743), and PIMCO Europe Ltd- Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf, London E14 5HS) in the UK. The Amsterdam and Italy Branches are additionally regulated by the AFM and CONSOB in accordance with Article 27 of the Italian Consolidated Financial Act, respectively. PIMCO Europe Ltd services and products are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH(Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) is authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The services and products provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 31a para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-, Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services and products provided by PIMCO Switzerland GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862 (PIMCO Australia) offers products and services to both wholesale and retail clients as defined in the Corporations Act 2001 (limited to general financial product advice in the case of retail clients). This communication is provided for general information only without taking into account the objectives, financial situation or needs of any particular investors. | PIMCO Japan Ltd (Toranomon Towers Office 18F, 4-1-28, Toranomon, Minato-ku, Tokyo, Japan 105-0001) Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No.382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association and The Investment Trusts Association, Japan. Investment management products and services offered by PIMCO Japan Ltd are offered only to persons within its respective jurisdiction, and are not available to persons where provision of such products or services is unauthorized. Valuations of assets will fluctuate based upon prices of securities and values of derivative transactions in the portfolio, market conditions, interest rates, and credit risk, among others. Investments in foreign currency denominated assets will be affected by foreign exchange rates. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | PIMCO Latin America Edifício Internacional Rio Praia do Flamengo, 154 1° andar, Rio de Janeiro – RJ Brasil 22210-906.


Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

This material contains the current opinions of the authors but not necessarily those of PIMCO and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. ©2015, PIMCO.