In a recent Viewpoint, we looked at the potential implications of rising household debt in Australia for both monetary policy and real activity. Economic theory tells us that unanticipated increases in household wealth lead to increased consumption, known as the “wealth effect”. Increases in asset prices can be caused by factors such as higher wage expectations, profits or rental yields, or alternatively, irrational exuberance. So, the key questions are: In which category do recent Australian house price increases belong? Is there a housing bubble in Australia, and how would households react to a potential decline in wealth? By many measures, like the rent-to-price ratio, Australian homes look expensive. Will Australian households deleverage as prices go down as they levered up when the going was good?
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