Who pays higher interest rates?

From Challenger Chief Economist Dr Jonathan Kearns

With high interest rates chasing high inflation, there has been push back by some saying higher interest payments constrains spending by few households, and so monetary policy is ineffective.

That ignores that monetary policy also affects economic activity through its impact on the exchange rate, on the incentive to save and invest, and on asset prices. And the data does show that the ‘cash flow channel’ of higher interest payments affects a broad range of households, and higher rates are having a large effect on an increasing share of households over time.

Over 80% of working age households have debt, and this share has been constant for the past decade. However the share of retiree households with debt has increased.

Some households only have small debt balances (say credit cards) or large interest bearing assets (bank accounts or bonds).

We can get a better sense of which households are most affected by higher rates by focusing on households with debt-to-income ratios exceeding three. This share of more heavily indebted households has increased, particularly for older working households.

The median debt-to-income ratio of those households with debt has also increased for most households of working age. So the effects of higher rates are felt by many households.

And a hair-raising bonus. The RBA Governor got a hard time in the media for noting that domestic inflation was widespread, including for haircuts and dentists. However, the 7% increase in the cost of haircuts over the past year pales in comparison to the 37% hair-raising inflation in the 1970s and even the 12% inflation when the GST was introduced. But this Christmas season we can all do our part to bring inflation down if we “let it grow, let it grow, let it grow”.

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