New RBA research reveals why so much of monetary policy has been focused on borrowers

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Borrowers are still more important than savers when it comes to monetary policy, new RBA research shows.

Australia has roughly the same number of households who are net lenders as it does borrowers, but because the level of debt borrowers are carrying on average – mostly via home loan mortgages – is around three times the level of lending, households are more important for the transmission of monetary policy in Australia.

“In real terms, the average borrower held about $230,000 in net variable-rate debt while the average lender held roughly $80 000 in net interest-earning liquid assets,” Gianni La Cava, Helen Hughson and Greg Kaplan say in their research.

“This suggests that lower interest rates will boost interest-sensitive cash flows, on average” the authors said.

The authors looked at the reaction function of debtor households to changes in interest rates – what they call the “borrower cash flow channel” – against the reaction function of investor households – “the lender cashflow channel” – in the economy and concluded:

The borrower channel is a stronger channel of monetary transmission than the lender channel, such that lower interest rates will typically increase household cash flows and lead to higher spending in aggregate. The central estimates imply that lowering interest rates by 100 basis points would be associated with an increase in aggregate household expenditure of about 0.1 to 0.2 per cent per annum.

And, at risk of belabouring the point, they said “overall, the household cash flow channel appears to be an important channel of monetary transmission in Australia”.

The research helps explain why the RBA continued to cut rates, even though former RBA governor Glenn Stevens once remarked some years ago that he understood how savers feel about lower rates because he was receiving lots of feedback from them as income from their term deposits shrank, but the bank kept cutting anyway.

One other crucial detail the research showed – and something Stevens and other RBA speakers highlighted over the years – is that “mortgage borrowers have used some of the cash flows generated by lower interest rates to prepay their mortgages rather than spend”.

Naturally, that impacted the reaction function between lower rates and spending, and also reduced the “expected life of household debt and hence bring forward the day when households feel comfortable about increasing their consumption”.

That’s something Stevens hinted at during the dark days of the GFC when he talked about householders getting comfortable again with their situation.

It also supports the RBA’s oft-quoted point that the fact Australian households are well ahead on the mortgages means they have a solid buffer against an economic downturn embedded in their household balance sheet.

It’s good for financial stability and it’s a shock absorber when Australian growth slows in the future.

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