A permanent reduction in average inflation should be expected to reduce nominal interest rates on deposits and loans by the same amount. Together with financial deregulation, which reduced interest margins and made housing finance more accessible, the reduction in nominal interest rates in Australia since the 1980s has eased the initial repayment burden of a given-sized debt. Households have therefore taken advantage of their increased capacity to borrow, resulting in rapid growth in household debt over the past decade or so. Consequently, the ratio of household debt to disposable income in Australia has increased from a level well below that in other developed countries, to something close to the upper end of the range of international experience.
In the process of transition to the new equilibrium, household credit should be expected to grow much more quickly than income. This has certainly been the situation in Australia in recent years. However, knowing that such a transition is in progress is not enough when trying to interpret correctly the current expansion in credit. It is also important to understand when the transition will end, and what the new equilibrium debt levels will be – or indeed, whether the process has gone too far and must partly reverse to reach its long-run sustainable path. This paper reports some analysis that tries to provide a sense of the likely magnitude of the change and its determinants, although it does not go as far as predicting the timing of the end of the transition or the new equilibrium debt/income ratio.