The Reserve Bank is incorporating what it sees as a weaker relationship between consumption and housing wealth, or home owners using their houses like an ATM, into its Monetary Policy Statement projections, Deputy Governor Geoff Bascand says.
In a speech to the Australia National University in Canberra, Bascand said the Reserve Bank is taking account of changing household saving and spending behaviours in its inflation forecasts.
"Weaker spending than expected out of wealth is part of the reason why inflation has been lower than forecast. We have been gradually incorporating the weaker relationship between consumption and housing wealth in our projections in recent Monetary Policy Statements, as our understanding of household behaviour has improved," Bascand said.
He said Australasian savings and spending patterns were proving to be different to those in other developed economies.
"Internationally, demand dynamics have changed since the global financial crisis (GFC), challenging inflation modelling and, in some cases, inflation-targeting frameworks."
"Some economists suggest that we are now in an era of 'secular stagnation', with persistent low demand due to higher saving and a reduced tendency to invest, driving down the long-term real neutral interest rate. Others point to an overhang from earlier excessive debt accumulation and suggest that demand is being depressed by a lengthy period of deleveraging (reduced borrowing)," said Bascand.
"Across advanced economies, investment has been weak and national saving rates on average haven’t altered significantly since the GFC."
'Australasia is different'
However, a different scenario emerges in Australasia, he suggested, with Australia and New Zealand seeing an increase in saving, notably by households. There has also been steady output growth supported by robust investment.
Bascand said developments in Australia and New Zealand were more consistent with a "debt overhang hypothesis" than "secular stagnation" in aggregate demand associated with excess saving and a long-term decline in the real neutral rate of interest, or the neutral interest rate.
“In Australasia the current outlook looks a lot like that which prevailed before the 2000s. In other advanced economies, weak investment growth, coupled with a disappointing expansion in the supply side of the economy, points to a world more consistent with lower long-term growth expectations," Bascand said.
“To what extent heightened household saving preferences in Australasia represent a permanent shift or a prolonged deleveraging adjustment is uncertain. Some indicators provide tentative support to the view that it represents a prolonged cyclical correction.”
He added that the rate of growth of consumption, including the relationship between consumption and wealth, was key to the Reserve Bank’s assessment of business cycles and inflation.
"Projections of demand arising from historical estimates of consumption from wealth have been over-optimistic. Weaker spending than expected out of higher housing wealth is part of the reason why inflation has been lower than forecast," said Bascand.
"Taking into account the increase in household saving we have seen, the links between interest rates, output and inflation appear stable."
“Currently, we are projecting per-capita consumption growth to improve and provide an impetus to output growth. The acceleration is modest compared to the previous cycle as household saving is expected to remain positive over the forecast horizon," said Bascand.
'Net equity withdrawal from housing wealth has so far been confined to the early to mid-2000s'
Bascand went on to say that the strong house prices rises of the early 2000s were associated with strong growth in credit and consumption, noting analysis of “housing equity withdrawal” through which households either borrowed against rising house prices, or sold down to realise the gains and potentially to finance general consumption.
"Equity withdrawal represents one mechanism for dissaving... It is clear that net equity withdrawal from housing wealth has so far been confined to the early to mid-2000s, which coincided with strong household consumption growth and a fall in the household saving rate. Although there has been a large rise in housing wealth in New Zealand and associated credit expansion since 2013, equity withdrawal has not eventuated according to our measure. The introduction of loan-to-value restrictions for housing loans since 2013 has likely played a part in offsetting credit growth related to the resurgence in housing market activity. Likewise in Australia, housing equity withdrawal was only a phenomenon that occurred in the early to mid-2000s," said Bascand.
In Australasia since the GFC saving appears to have risen more sharply amongst the most heavily-indebted households, he added. Although house price inflation has been strong and housing credit growth robust, this appears to reflect "portfolio adjustment", or an asset price response to low interest rates, and rapid population growth, Bascand said.
"This cycle has not seen the pattern of equity withdrawal that characterised the excessive growth in leverage of the early 2000s. Modelling suggests that the elasticity of household spending in response to housing wealth has moderated since 2005."
'A downward assessment of future income prospects'
The Reserve Bank has recently analysed household saving in New Zealand using Household Economic Survey (HES) data comparing consumption and saving across households in 2007 and 2013.
"The HES data shows a smaller increase in the median saving ratio relative to the rise in the overall level of saving (or the aggregate saving ratio). This appears to be explained by much lower dissaving among individuals below the median as opposed to higher saving among those above the median. The saving ratios at the top end of the saving distribution are largely unchanged. Similar to Australia, saving rose much more sharply for higher educated households (those holding a degree), suggesting a downward assessment of future income prospects, such that much of the income growth over the period was saved. Another parallel with the Australian study is the significant reduction in dissaving amongst those with the highest debt-to-income ratio, supporting the notion of a debt overhang and a desire amongst such households to lower their debt ratios, or a reduced supply of lending to such households," said Bascand.
The Reserve Bank's study, and a similar one by the Reserve Bank of Australia, suggest; "tentative evidence of a recent shift in saving behaviour in Australasia owing to pessimism around income growth and the negative shock to wealth emanating from the GFC. The former would suggest a more enduring change, while the latter is more consistent with a prolonged cyclical adjustment."
"In both countries, there is no obvious sign that ageing demographics (i.e. an increasing concentration of middle-aged households with higher saving rates) had a strong influence over the change in saving behaviour during the period. When adjusted for changes in the age composition of households, the aggregate saving ratio in 2013 was only marginally lower than the unadjusted rate, implying that most of the (large increase) was due to economic factors.Correspondingly, the increase in the saving rate was smaller amongst the 50-64 year old age cohort than it was for the 30-49 cohort or the 65+ group," said Bascand.
The Reserve Bank's Policy Targets Agreement (PTA) with Finance Minister Bill English requires it to keep inflation between 1% and 3% on average over the medium term, with a focus on keeping future average inflation near a 2% target midpoint.
In the September 2016 quarter the Consumers Price Index (CPI) rose 0.3%. And for the year to September 2016 the CPI inflation rate was 0.4%.
In this month's Monetary Policy Statement the Reserve Bank forecast annual CPI inflation would rise to 1.1% in the December quarter, but not reach 2% until the December 2018 quarter. It has now been below 1% since the September quarter of 2014, and was last above 2% in the September quarter of 2011.