RDP 2021-10: The Rise in Household Liquidity 8. Conclusion

It is well documented that household wealth has risen significantly in recent decades and that the value of both household assets and debt has increased. We document a less well-known phenomenon that has occurred in almost every advanced economy: household liquid assets have risen strongly relative to income over the same period.

Household surveys indicate that liquidity buffers are strongly associated with life cycle factors, such as age and housing tenure. The increase in buffers over recent decades has been broad based across households, though strongest amongst households with mortgage debt. Consistent with this, the share of liquidity-constrained households has declined significantly.

The growth in liquidity buffers is closely connected to developments in the housing market through multiple channels. First, higher housing prices have encouraged potential home buyers to accumulate more liquid assets in the process of saving for a deposit. Second, higher mortgage debt has increased the repayment risks associated with future income shocks and led indebted home owners to build liquidity buffers for precautionary reasons. The process of debt amortisation has been supported in Australia by unique financial innovations such as mortgage offset and redraw accounts that have increased the liquidity of housing wealth.

Our findings demonstrate that the decades-long expansion of household balance sheets does not necessarily mean that households have become overextended. A little recognised ‘side effect’ of rising housing prices and debt has been the increased rate of housing-related saving through higher mortgage principal payments. This increase in housing-related saving has been supported by the decline in interest rates and has allowed indebted households to build larger liquidity buffers. To the extent that more liquidity is associated with less financial stress, our results suggest that the higher ratio of debt to income has not made the household sector more financially fragile.

The significant decline in liquidity constraints amongst households with mortgage debt indicates that the repayment risk associated with aggregate mortgage debt has declined over recent decades. However, to the extent that rising housing debt has increased the risks associated with future income shocks, and hence caused households to reduce their spending for precautionary reasons, it may be welfare reducing from a macroeconomic perspective.

Finally, it is surprising how unique mortgage offset and redraw accounts are by international standards given their importance to the process of debt amortisation and the accumulation of liquidity buffers. These accounts make housing much more liquid and potentially allow home owners to better smooth consumption in the face of unexpected income and wealth shocks. It would be interesting to investigate the macroeconomic and financial stability implications of such mortgage accounts. For example, these accounts may make aggregate consumption less volatile in Australia than other comparable countries. They may have also reduced liquidity constraints by more in Australia than elsewhere, with a potential bearing on financial stability risks stemming from the household sector.