The housing-retail link

Feedback loops are an important concept in finance and economics. In a nutshell, positive feedback loops are pro-cyclical in that they act to make an economy more volatile by accentuating booms and then busts. By contrast, negative feedback loops are counter-cyclical in that they act to reduce volatility and make an economy more stable by mitigating boom/bust cycles.

Positive feedback loops come in various forms. With respect to the Australian housing market, there are two positive feedback loops that can dramatically impact the Australian economy via their effect on the level of credit growth, aggregate demand, and employment:

  1. mortgage hypothecation – the process whereby increases (decreases) in home values result in decreases (increases) in bank capital adequacy requirements, leading to increases (decreases) in mortgage lending; and
  2. wealth effect –  the process of rising (falling) asset prices leading to rising (falling) consumer confidence, borrowing, household expenditure and employment.

The topic of mortgage hypothecation has been explained in detail by fellow MacroBusiness blogger, Deep T., and I will not expand on it further in this post [For a quick primer, read this article].

Rather, I want to focus on the second point – the link between Australian home values and consumer confidence, borrowing, household expenditure and employment.

This is a topic that I have discussed several times before. For example, in Why Australian’s aren’t spending, I argued the following:

…throughout the 2000s, when global credit conditions were benign, household debt levels and asset prices rose continually. These conditions made Australians feel richer (the ‘wealth effect’), spurring consumer confidence, spending and employment growth…

With house prices rising inexorably, Australians began using their homes as ATMs, withdrawing large amounts of their new found home equity…Much of this money was spent on consumption, thus further boosting incomes and employment.

However, the process of debt feeding asset prices feeding confidence, consumer spending and employment growth appears to have stalled now that house prices have flat-lined. Australians have, instead, begun reducing consumption and repaying debt…

The golden era for retailing that was 2000 to 2008 is now over and the age of frugality has begun.

Recently, a number of reports have explained the ‘wealth effect’ positive feedback loop in greater detail.

First, today’s Australian Financial Review contains an interesting article entitled Falling house prices stifle shopping, which draws on research by Citigroup showing that changes in home values are a leading determinant of household consumption expenditure:

Retailers can blame the poor housing market for lacklustre consumer spending and should expect the weakness to continue…

Citigroup…found that changes in personal wealth, together with income and interest rates, play a big role in spending…

The largest determinant of household consumption is income… But changes in the value of household assets are a leading determinant too. Houses comprise about 60% of household assets…

A 10% increase in wealth translates to 1.7% growth in final consumption expenditure in the following quarter.

This means that when house prices go up, people spend more.

The problem for retailers has been that most peoples largest asset is their home, and property values have been falling, or have been at best flat in recent months.

Citigroup’s findings are supported by recent experience in Australia, New Zealand and the United Kingdom, where the rapid rise in household net worth up until 2007, most of which was on the back of rising home values, led to households withdrawing large amounts of home equity between 2001 and 2008. Much of this borrowing was spent on consumption, which further boosted incomes and employment.

To illustrate, consider the following charts showing home equity withdrawal in those countries.


New Zealand:

United Kingdom:

In all three countries, rising home values between 2002 and 2008 created a positive feedback loop whereby households borrowed against their homes to fund consumption expenditure.

However, as soon as the Global Financial Crisis hit, and housing prices corrected, households began reducing consumption and repaying debt, as evident by the increasing home equity injection.

Another recent report by Deutsche Bank also lends weight to the positive feedback loop created by rising (falling) asset values. The report argues that wealth and the terms of trade have been key determinants of household savings over the past 40 years, and sees these factors as being behind the recent rise in the household saving rate.

In regards to the ‘wealth effect’ discussed above, Deutsche provides the below chart plotting the household savings rate against private sector wealth. As you can see, much of the decline in the household saving rate (the flip-side of which is increased borrowing) since the early 1980s can be attributed to a rapid increase in wealth over that period, much of which was due to rising home values. Figure 1 also shows the negative wealth shock seen during the GFC, and the associated increase in saving.

Once the positive feedback loop caused by rising (falling) home values is understood, it’s easy to dismiss the common misconception that unemployment would need to rise before home values would fall. Rather, rising (falling) home prices tends to lead decreases (increases) in unemployment simply because of the wealth effects described above.

Put simply, as long as Australian housing values remain stagnant or falling, consumption expenditure, credit growth and job creation will remain subdued, even with Australia’s terms of trade near century highs.

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Unconventional Economist


    • The_Mainlander

      Tip 1: don’t buy in a bubble market!


      Oops no that was not in there was it!

      Oh bugger it was! OMG!


      The ‘real list’

      1. Put all of your savings into your home loan (the use your Super… sell your soul and still lose the lot)

      2. Try to have at least 30% equity in your home (umm rob a bank real quick before the banks default or sell ya Mum?)

      3. Don’t buy before you sell in this market (huh?)

      4. Don’t be a forced seller (OMG – of course all ‘forced sellers’ choose to be ‘forced sellers'(Oh please Kochie))

      Oh noes I think the years of up-up-up property always goes up have left Kochies struggling for ideas about what to write now it is all about down-down-down and “How the f*** do I dig myself out of this leveraged money pit called a mortgage with no deposit down?”

      Oh boy this year is really bring flocks and flocks of chickens home to roost!


    • The one thing I disagreed with from Louis Christopher is towards the end that Australia wont experience a massive fall like the US because fundmentally Australia is different. Bullshit. The banks are carrying 50% plus of their business on house mortgages. The banks have over 2 – 3 trillions dollars of overseas investors money that the govt has guaranteed till Oct 11. It is fundmentally different because if those overseas investors get spooked and raise their rates to the banks what do you think the banks will do. Also what if they want their money back the banks wont have it then the govt will have PRINT some money. The RBA may not have the luxury of dropping rates as the banks wont be able to pass that on if the overseas investors get spooked. Australia is fundmentally F#$KED and different if things start to really go south. It sure looks like it has started.

      • LBS – couldn’t agree more.

        The austerity that is going to befall this country is going to be massive when you factor in the exposure our banking system has to off-balance-sheet derivatives. Our manufacturing base has been guttered, the majority of profits from the resource sector have gone overseas and globalisation has made us extremely vulnerable to international shocks.

        Australia is just a pawn in this worldwide chess game orchestrated by the few who hide behind organisations that pull the strings of government.

  1. “a positive feedback loop whereby households borrowed against their homes to fund consumption expenditure.”

    Thats it in a nutshell.

    Consider the 500K house going up by 7%pa (housing doubles every 10 years!), thats $35,000 a year or $95 a day in “equity mate” to grease the poles at Hardly Normal or Boganville Holden.

    Now consider $95 a day of your ‘perceived’ wealth disappearing into the ether.

    Great post BTW LVO. May not totally kill the internet destroying retail myth but the real culprit is there to behold.

  2. Would I be going out on a limb if I said Macrobusiness is redefining the way in which Economics reporting/analysis is conducted in this country?

    Collectively, this work is astounding in both breadth & depth. I dont see anything else like it worldwide.

    I must be dreaming. Keep going!

  3. There’s an article linked to from the wikipedia “wealth effect” page seeking to debunk the connection between reduced spending and falling house prices. However it’s from 2008.

    Perhaps we can argue “it’s different there” in a zerohedgian way: people not paying their mortgage juice the US GDP by quite a bit: (it could happen here if the loans turn into zombie loans, Hardly Normal becomes Hardly Zombie …).

  4. 100% agree with your article Leith.

    The days of strong growth powered by domestic consumption backed by increasing private debt are over. The problem with using debt to spend like there’s no tomorrow is that tomorrow always comes regardless.

  5. It isn’t *falling* house prices that cause the problems, it’s *house prices that are not rising*. That includes prices that aren’t changing at all. This is the real issue with people saying “prices just won’t go anywhere for a few years”; if that happens, the economy won’t go anywhere, either.

    If people start losing jobs as a result (and I suspect they will) we’ll start to see forced sales.

    • Yes… This point was noticed and exploited handsomely by some of the guys in the US who made a killing betting against the US Housing market.

      People like Greg Lippmann and John Paulson both did some excellent research into what drove house prices and found a clear relationship between house prices and rates of defaults. That is the States with the lowest defaults had the highest price growth, regardless of any other factors (such as population growth, employment etc).

      They also noted that this relationship was true over many decades and quickly figured out that it would be sword that cut both ways.

      It was immediately apparent that red hot real estate areas (such as California) were actually poor credit risks, not good ones.

      In short they quickly realised that house prices only need to stagnate for a while for things to start becoming unstuck. And like a runaway train, it would get up enough speed to become unstoppable.

      Which indeed it did…

      The best read I have had on this is “The Greatest Trade Ever” by Gregory Zuckerman. Well worth a look if you are interested in what happened in the US Housing market.

  6. Systems based on positive feedback loop can experience two behaviours:
    – oscillations (desired by economists but requires week and stable positive feedback)
    – runaway effect often with destructive consequences

    Western “laissez-faire” economies are just big positive feedback loops. House prices are rising just because they are rising; stock market is rising just because it’s rising; same for commodities, forex, credit is growing just because it is growing; …

    • Only financial markets have positive feedback loops. Labour and goods markets are the opposite.

      Saying this is the fault of ‘laissez-faire’ economies is misleading. The issue is under regulated financial systems, not under regulated economies.

  7. This is the real problem for the bullhawks calling for several rate rises this year. Another (say) 75bps this year will accelerate the downtrend in house prices and crush consumer confidence in mainstream Australia.

    The inevitable outcome is a recession in the mainstream economy, while mining continues to boom (as long as the China doesn’t stumble). The political implications of this scenario are HUGE. I dare say the idea of an independent central bank, unanswerable to the people, could come into question.

    • Drederick Tatum

      geez 75bps would smash some housing markets wouldn’t it?

      Steve Keen was 4 years too early.

      • On the contrary, his early warning (and the FHVB) gave switched on people enough time to get out.

    • Treasury and the RBA will say this is the ‘transition we had to have’ to move to the 21st century model of the Australian economy: resources and services…

      If consumer/household spending remains subdued, I don’t see the need to raise rate 75bp.

      And don’t forget – the RBA need only remind where the responsibility for debt stress really lay – the consumer. Rates are not fixed. We are reaping the benefits of globalisation and a floating currency.

  8. This is great stuff again, thanks Leith.
    It seems to me that the age of consumerism, which has existed almost my entire life, is over. An absolute cultural change, no less. Interesting.

  9. When positive is negative.

    Great article Leith. However, I would suggest to all, to go to Wikipedia and read, the links are provided above on positive and negative feedback loops.

    E.g. Unintended positive feedback may not be “positive” in the sense of being desirable. Positive refers to the direction of change rather than the desirability of the outcome. To avoid this confusion, it is sometimes better to use other terms such as self-reinforcing feedback.[3] In social and financial systems, positive feedback effects may also be referred to as ‘virtuous’ or ‘vicious’ circles.

    Lets head off the confusion posse before it reaches the pass, i.e. send button.

  10. I think you could add into this equation that savings are taxed but debt can be a tax relief. No incentive there as I see it

  11. On this topic, I like to put in a plug for Fred Harrison. Read his article, “The Mystery of Britain’s Missing Recession”, written in JUNE 2005……!!!!

    I am astounded that this feedback cycle has not been grasped in the mainstream long since. Surely Gordon Brown knew what he was doing – and Michael Cullen and Aussie’s Finance ministers? In Michael Cullen’s case I am willing to believe he knew he was making a poison pill for the other main party when they became govt – his mind obviously works this way. I am also willing to believe that he was too much of a socialist to actually understand at all.

  12. And I agree with the chorus of praise for Macrobusiness Blog and Unconventional Economist in particular. This is a haven of intelligence and honesty.

  13. Hey Leith you are selling out …
    I see this has been picked up by SMH

    I would like to think that this little treasure of a website wasn’t going to get the mass bogan posting but alas you go and hoist the main sail …

    I had a sneaking suspision that some of the MSM was lurking around

  14. Well worth the read ..Leith,as is
    Deep T’s article worth a read ,having
    what has transpired since..


    The value of Jobs…. and the added value
    they valued….Built the inverted
    pyramid to crack..
    ….cheers JR