Yves here. Even though the finding are from Australia, which has had a bigger and longer-lasting housing bubble than the US or UK, it’s not hard to see that the same factors are likely at play in other economies. Recall separately that a lot of research has found that increases in household debt are correlated with slower productivity growth.
By Leith van Onselen, an economist who has previously worked at the Australian Treasury, Victorian Treasury, and Goldman Sachs. Originally published at MacroBusiness
The Australian Housing and Urban Research Institute (AHURI) has released a new report exploring “the nature and magnitude of the relationship between house prices, household debt and the labour market decisions of Australian households”, which paints a sobering picture for the economy and financial stability.
The key conclusion from the report is that “households accumulate debt as house prices increase, leaving them vulnerable to housing and labour market shocks. House price increases also potentially promote or dampen labour supply and labour force productivity”. In other words, Australia’s housing bubble is distorting the economy.
The report notes that Aussie home owners tend to borrow more as their home’s value increases, and that this ‘wealth effect’ is greater than in the US or UK:
Overall, the results indicate that a $1,000 increase in housing wealth is associated with an increase in debt of approximately $240 per annum. This is a large response compared to the magnitudes found in studies in the United States and United Kingdom…
House price increases are associated with larger increases in total indebtedness for home owners with higher initial loan-to-value (LTV) ratios. Home owners with larger values of non-mortgage debt as well as higher LTV ratios are more sensitive to house price movements compared to other home owners…
The take-up of further mortgage debt among vulnerable highly leveraged households exposes them to income, housing and financial market shocks. The results are in contrast to the general belief in Australia that debt is held by those most able to service it—higher income and high-wealth households. Macroeconomic policy-makers should interpret high levels of debt and rising household debt-to-income ratios in Australia carefully.
Overall, the findings show that house price changes influence household debt through two channels: a direct wealth effect and an indirect collateral effect via the household’s borrowing capacity. That is, some households face borrowing constraints and, for these households, rising house prices increase the value of their property that may be used as security for a loan and thereby loosen the borrowing constraints…
Our results indicate that in response to increasing house prices, some home owners, especially home owners with low debt, engage in debt financing of consumption (involving extracting equity from their home). Other home owners, especially those with relatively high debt levels refinance existing mortgages or adjust existing debt portfolios.
The report also found that rising house prices dampens labour force participation and hours worked, thus presenting a downside for the economy as productive workers withdraw from the labour market, as well as making it more difficult to counteract the impacts of an aging population:
The most important responses are in labour participation and hours of work by women, both partnered and single. The effect is strongest among the older cohort of women and is associated with early retirement for those experiencing above average housing wealth gains.
Younger partnered men and women exhibit a reduction in hours of work in response to the gain in housing wealth. That is, these gains in wealth effectively fund time away from work to undertake non-market activities such as providing household care for children, ageing parents, undertaking volunteer work or enjoying more leisure.
AHURI notes that its findings have important policy implications for macroeconomic stability:
The take-up of further mortgage debt among highly leveraged households exposes those households to the risk of significant loss if house prices fall or if interest rates rise. This, in turn, may pose a systemic risk for the macroeconomy.
An economic shock, emanating in either financial, labour or housing markets, may lead to widespread defaults that would cause the shock to spread across markets and threaten the performance of the aggregate economy.
Therefore, policy-makers may need to consider limits on, or regulate the risks associated with, the continued collateralisation of debt in a potential deflationary environment.
There are also implications for retirement incomes:
The analysis reveals that higher house price growth is associated with early retirement for women (though not for men). Consequently, public policies that contribute to house price growth can induce earlier retirement among home owners, particularly if equity withdrawal to fund consumption is facilitated.
As well as implications for labour force participation and productivity:
Productivity growth is the foundation of sustained improvements in the standard of living and hence represents a prime concern of policy-makers. The results of the research presented in this report highlight two ways in which housing and housing finance-related policies might influence productivity growth.
First, results indicate that housing policies can play a potentially important role in driving labour market participation decisions in Australia, and hence should be considered in conjunction with other labour market policies to encourage employment participation…
Second, as house price growth tends to affect labour supply, while simultaneously making it more difficult for renters to become home owners, policies that dampen house price inflation (e.g. new housing supply) may also contribute to labour force productivity growth.
And that’s why Australian multi-factor productivity stopped growing at the turn of the millennium.
The full report can be found here.