Borrowing ‘extra’ not housing-related, researcher says

Households tend to “borrow more” for investment purposes, such as to buy shares or to buy cars, but not for housing as income inequality in their local area rises, a Reserve Bank of Australia-backed research paper had found.

Member of the micro analysis and data team in the RBA economic research department, Kim Nguyen, and her associates discovered that households may try to ‘keep up’ with their more affluent neighbours by borrowing more in certain circumstances.

The report outlined that additional debt tends to be taken out by middle-income households that are financially comfortable, noting this has a number of “important implications”.

For investment debt, it suggested that “these middle-income borrowers are trying to close the ‘income gap’ with their rich neighbours through investment that can raise future income”.

Additionally for car debt, it suggested that households may be taking out debt to “keep up with their richer neighbours through ‘conspicuous consumption”, it explained.

Ultimately, it resolved, that “these households are unlikely to have difficulty repaying their debt” and “as such, there is limited financial stability concern.”

Household borrowing stretched further

Ms Nguyen highlighted that inequality has become an increasingly important topic among researchers and policymakers both in terms of what causes inequality and what effects it can have on growth and the economy more generally.

“One channel through which inequality could affect the economy is by influencing the amount of borrowing, and its allocation across households,” she explained.

“In particular, some have argued that in local areas where incomes are very unequal, households may try to ‘keep up’ with their more affluent neighbours by borrowing more.

“This has important potential implications for both financial and economic stability if it leads households to borrow too much and become more sensitive to negative shocks.”

In terms of the research’s importance, Ms Nguyen explained that while nationwide income inequality in Australia is similar to other countries and has been stable over the past decade, income inequality within local areas often changes over time.

The gap between people with the highest and lowest incomes can differ substantially across areas, she added.

“As households may make their borrowing decisions using their neighbours as a reference point, this suggests that local income inequality could have a moderate effect on household debt,” Ms Nguyen said.

As such, Ms Nguyen said the research sought to answer the following:

• “Do Australian households borrow more as income inequality in their local area increases?”
• “What do they borrow more for? For instance, to buy property or other assets, or to consume more?
• “Which types of households borrow more? What are their demographic and financial characteristics, and does this have implications for financial and economic stability?”

It’s driven by the middle class

Ms Nguyen confirmed she found “evidence of ‘keeping up with the Joneses’-type dynamics in Australia”.

She explained: “Specifically, there is a significant positive association between local income inequality and household investment debt.”

“The accumulation of investment debt is mainly driven by middle-aged and middle-income mortgage holders without liquidity and borrowing constraints and who are willing to take financial risk.

“Car debt also increases moderately with a rise in local inequality, driven by middle-aged outright home owners who self-perceive as financially prosperous.

“The accumulation of car debt lends evidence to the traditional ‘conspicuous consumption’ channel, with households trying to close consumption gaps in a conspicuous manner.

“On the other hand, the accumulation of investment debt suggests an additional channel for the ‘keeping up with the Joneses’ hypothesis – households borrow to invest, in the hope of keeping up with a rising local income gap.

“Such a channel could be particularly concerning if the households that take on the additional risky investments were financially fragile. However, in Australia it appears that they are taken on by households that are financially comfortable, lessening such concerns.

[Related: New report finds over a third of Australians are financially illiterate]