Families add debt to buy shares or new cars
Australian households tend to borrow more to “keep up with the Joneses” as income inequality rises in their local areas, according to new research published by the Reserve Bank of Australia.
Authored by RBA lead analyst and economist Kim Nguyen, the paper found that the added debt taken on by these households typically went into non-residential investments such as buying shares or new vehicles, suggesting that borrowers are looking to close the income and consumption gaps perceived within their area.
Nguyen said income inequality within local areas often changed over time, despite being relatively stable over the past decade nationwide. As such, the gap between households earning the highest and lowest incomes can differ substantially across areas.
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In examining how this inequality influences the amount of borrowing, Nguyen’s paper analysed household panel data from the Household, Income and Labour Dynamics in Australia Survey, which reflected existing assertions that people make their borrowing decisions using their neighbours as a reference point.
“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,” Nguyen said. “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.”
Nguyen’s analysis revealed “a significant positive association between local income inequality and household investment debt,” driven largely by middle-aged and middle-income mortgage holders that do not have liquidity or borrowing constraints.
The paper also found that car debt “increases moderately with a rise in local inequality, often taken on by middle-aged outright homeowners who self-perceive as financially prosperous”.
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In both cases, the added debt was indicative of what Nguyen called “‘keeping up with the Joneses’-type dynamics” .
The accumulation of car debt, for example, pointed to the “conspicuous consumption” channel, where households try to close consumption gaps in a conspicuous manner. On the other hand, Nguyen said the accumulation of investment debt suggested that “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,” Nguyen said. “However, in Australia it appears that they are taken on by households that are financially comfortable, lessening such concerns.”
