The Changing Economy

[ The University of Melbourne Voice Vol. 3, No. 2  12 May - 9 June 2008 ]

After more than a decade of low inflation and economic growth, consumers may face a need to curb spending.

Professor Nilss Olekalns and Professor Kevin Davis discuss how consumers might be affected by impending changes in the economy in this interview introduced and led by Dr Angela Paladino.

Is the great Australian dream of owning a home now unattainable? Will you still be able to enjoy even a daily latte?

Q: What is the larger economic picture for the new financial year?

NO: There are signs the Reserve Bank believes that further interest rate increases will not be necessary. The US recession may not be as severe as was once feared. And global economic growth, in general, is still likely to hold up even if the US slips into recession.

Q: Why so much uncertainty about the threat of inflation and its effects?

NO: The strong demand for Australia’s commodities caused, in part, by the growth in China, has pushed Australia’s terms of trade to levels not seen since the early 1970s, a period when inflation did take off. A high terms of trade translates into high incomes for exporters, this flows on and can increase demand more generally, and this potentially fuels inflation.

It is important to remember, however, that Australia is a very different place from what it was in the 1970s. In particular, the labour market is much more deregulated and so the possibility of a wage-price spiral adding to inflationary pressures is now remote. We also have much better policy institutions.

Q: What impact will the US sub-prime lending issues continue to have on Australian banks and consumers?

KD: Australian banks have largely avoided direct exposure to loss from US sub-prime loans and the complex derivative securities from those loans, constructed by financial engineers, though some local investors haven’t been so fortunate. We have not had a situation of similar sub-prime loans being made to households here.

Our home-grown sub-prime lending problems relate more directly to bank lending exposures to complex business structures of heavily leveraged investment-finance companies (eg, Centro, Allco, MFS) and stock-broking/margin lending companies (Opes Prime and Lift Capital). These problems have exposed a number of deficiencies of practices in our securities markets and have cost many share market investors dearly.

There is no evidence of any significant number of Australian home owners being in the dire straits of US sub-prime borrowers faced with the combination of the end of excessively cheap honeymoon interest rates and falling property prices. But many households have recently bought homes (or investment properties in search of capital gains) with very high loan/valuation ratios and high debt service ratios. For them higher mortgage interest rates and possibly declining house prices will create significant financial stress. That would be further aggravated if the effects of a recession in the US spread here.

Q: Why, in such uncertain economic times, do we continue to spend?

NO: Consumer spending is one of the smoothest of all economic series. It is remarkably resilient, even in severe recessions. And while mortgage stress will certainly impact on some homeowners and lead to cutbacks in their spending, most homeowners will probably absorb the higher costs and maintain something close to their traditional spending patterns.

Q: Is there any way the government can curb or rein in such spending?

KD: There is only one way, and that’s monetary policy. It has to be remembered, however, that historically monetary policy has affected the economy not through modifying consumer spending but through its effects on planned spending by businesses. When interest rates increase, firms cut back on their investment projects and this can have flow-on effects for economic activity. This is how the 1990s recession came about.

Q: How will the decline and segmentation of home ownership in Australia affect society and the economy?

KD: It is not clear to me that home ownership should be seen as such an important issue. More important is available, affordable, adequate, accommodation – which includes both rental and ownership.

Traditionally, housing ownership has been seen in Australia as something of a holy grail – perhaps because for many decades it was the one viable option for many families to accumulate wealth, and saving for a deposit and subsequent mortgage repayments were a form of forced saving. Nowadays there are other savings vehicles such as superannuation.

There is perhaps more to be gained from policy-makers looking at how well our laws and institutions work in ensuring a well functioning house rental market than in focusing on home-ownership as such.

NO: This presupposes that the ‘great Australian dream’ is now unattainable. And we have seen some decline in home ownership rates, particular among those aged under 35. The big question is whether this has been due to a rise in the price of housing or are there other factors at work?

For example, we know that family formation is being delayed and this means the purchase of the first home now occurs at a later age than was once the case. And the home that they purchase may be different (perhaps smaller). But property ownership in some form will continue to be the focus for a great many Australians.


Professor Nilss Olekalns is Head of Economics, Professor Kevin Davis Director of the Melbourne Centre for Financial Studies, and Dr Angela Paladino a Senior Lecturer in Marketing, at the University of Melbourne.