Monetary Policy Transmission and Household Indebtedness in Australia

We highlight the importance of high and low states of household debt for the transmission of monetary policy in Australia during the period from 1994Q1 to 2019Q3. Using a state-dependent local projection model, we demonstrate that the impact of a monetary policy shock varies depending on the level of household debt. In particular, in low household debt conditions, output, investment, house prices, household debt-to-GDP, and debt-to-asset increase significantly to an expansionary monetary shock, while the responses of these variables are largely muted when the households are in a high-debt state. We infer from our results that the “home equity loan channel” may be active when household indebtedness is moderate, but inactive when it is high. We conjuncture that this channel likely played a crucial role in the transmission of monetary policy in Australia, and potentially accounted for the diminished effects of monetary policy under high household debt conditions.