Consumption, wealth and credit liberalisation in Australia

A stable, long run consumption equation is estimated for Australia using quarterly data from 1977(2) to 2008(2). The model incorporates non-property income, income expectations, uncertainty, disaggregated household wealth, demography and, importantly, a relaxation in household credit conditions attributable to financial liberalisation and innovation (FLIB). Over 1977-2008, the log consumption to income ratio rose by around 14 percentage points. The relaxation of households' downpayment and collateral constraints together boosted the log consumption to income ratio by about 31 percentage points, given the rise in house prices. However, this was offset by around -24 percentage points because of increased indebtedness and -6 percentage points due to higher real interest rates. The remaining rise in the log consumption to income ratio is then attributed to rising optimism in household income expectations, rising illiquid financial wealth, to demographic changes and to short term factors. The indirect effects of FLIB in the model are powerful. Prior to FLIB, intertemporal consumption smoothing is difficult and housing capital gains are inaccessible: there is no "classical" housing wealth effect. Once credit markets are liberalised in the early 1980s however, there is a significant role for variable real interest rates, income expectations and housing collateral as determinants in the long run consumption equation. The estimated long run marginal propensities to consume are around 0.06 for housing assets (post-FLIB), 0.01 for illiquid financial assets and 0.20 for net liquid assets.