RDP 2019-06: The Effect of Mortgage Debt on Consumer Spending: Evidence from Household-level Data 8. Conclusion

Consistent with international research, we find evidence that high levels of owner-occupier mortgage debt reduce household spending. Higher mortgage debt is associated with less spending even when we control for changes to net housing wealth and cash flow (adjusted for mortgage repayments). This implies that a deepening of both sides of the household balance sheet is associated with weaker spending, and that debt matters for spending over and above its effect on net wealth. In other words, we find that the composition of household balance sheets affects household consumption decisions, which contradicts the predictions of conventional theories, such as the PIH.

Overall, the negative effect of debt on spending is pervasive across households with owner occupier mortgage debt. In contrast to previous literature, we find little evidence for borrowing and liquidity constraints or precautionary saving motives to be key drivers of the negative debt overhang effect. While our results do not directly support the debt overhang mechanism, we rule out some non-causal explanations for the negative effect of debt on spending proposed in the literature.

Specifically, we find that neither spending normalisation nor a shift in household preferences to housing consumption can explain the negative effect of debt on non-housing spending. While we find that household spending is more sensitive to debt during adverse shocks such as the GFC and local housing price shocks, the negative effect of debt also persists in more ‘normal’ times.

Our results also suggest that an increase in aggregate owner-occupier mortgage debt can have important implications for aggregate spending, all else constant, and go at least part of the way to resolving the post-crisis ‘puzzle’ of unusually weak household spending in Australia.