RDP 2003-08: A Tale of Two Surveys: Household Debt and Financial Constraints in Australia 1. Introduction

Over the past decade, household debt (as a share of household income) has reached historically high levels. Between December 1990 and September 2002 the ratio of household debt to disposable income more than doubled from 50.5 per cent to 122 per cent (Figure 1).

Figure 1: Household Debt(a)
Per cent of household disposable income
Figure 1: Household Debt<sup>(a)</sup>

Note: (a) Excludes unincorporated businesses

Sources: ABS; RBA

This rise has been commented upon widely, including by The Economist, which remarked:

The profligacy of American and British households is legendary, but Australians have been even more reckless, pushing their borrowing to around 125 per cent of disposable income…there are now concerns that unsustainable rates of borrowing will sooner or later end in tears. (‘Living in never-never land’, The Economist, 9 January 2003).

Despite the intuitive appeal of a link between a rise in aggregate household debt to income ratios and financial fragility, there are a number of important considerations. For example, it matters who is holding the additional debt. If the run-up in debt is caused by lending to people with above-average capacity to service the additional debt at conservative loan-to-house valuation ratios there would be relatively little cause for concern.

This paper seeks to shed light on this issue by referring to household level surveys that provide detailed information on household debt and financial constraints. As alluded to above, it may be that the rise in the aggregate debt to income ratio has been accompanied by an increase in the proportion of financially constrained households. Alternatively, it may be that rising debt levels reflect a rise in people's capacity to borrow and, as such, are a reflection of good economic outcomes rather than a signal of greater fragility.

The remainder of this paper is organised as follows. In Section 2 we begin with a brief discussion of previous research in the area. Section 3 and 4 discuss the data we will use in this project and provide an initial picture of constrained and unconstrained households in Australia. To better understand the relationships involved we then estimate a model in Section 5 to examine the demographic and economic characteristics of households that help explain cash flow constraints in Australia. We then use this model to look at how changes in these characteristics over time may have influenced the prevalence of cash flow constraints for Australian households. In Section 6 we turn our attention to the related question of what factors might help explain the rise in the aggregate debt to income ratio. This allows us to answer our motivating question: has the increase in the aggregate debt to income ratio also been associated with an increase in the financial ‘fragility’ of households? Section 7 concludes.