How much financial pain is too much to inflict on young families struggling to pay off their first homes?
It’s a question many are starting to ask as high interest rates take their toll. And it’s a question we’ve asked before.
The pain of high interest rates is almost a generational rite of passage in this country. The baby boomers sweated as mortgage rates spiked above 20 per cent in the mid-1980s. In 2007, it was my generation (Gen X) panicking about rates above 10 per cent.
But as house prices have soared, the weight of that burden has grown.
It doesn’t matter how many flat whites or avocados young homeowners forgo, there is no getting around the awful maths of modern mortgage pain.
The median house price in 1984 was $56,600. In 2007 it was $345,000. In 2021 it peaked at $925,000, although it has slipped back to about $770,000 in the past 18 months.
Why do we do this?
Using monetary policy to target inflation has never been fair. Like democracy, it’s perhaps best described as the worst system apart from all the other alternatives.
Unlike other efforts to control pricing employed by governments over the years, it has one virtue — it actually works.
When inflation bites, we lift interest rates in an effort to reduce borrowing and slow the economy.
But it’s a tool that central bankers have never been shy of describing as “blunt”. The financial burden lands hardest on those who are the most-indebted — typically younger people who have entered the housing market more recently.
That’s part of the reason why monetary policy has worked so well in the past.
The younger demographic — those between 20 and 45 — is typically the biggest spending group in the economy. Older people are net savers.
So for monetary policy to transmit efficiently, it needs younger people to spend up when the aim is to expand the economy, then to cut back when things overheat.
That is happening now. Data this week showed retail sales down by 1 per cent in the June quarter.
But it has required one of the steepest rate hiking cycles in New Zealand history to get traction (the official cash rate has spiked from a record low of 0.25 to 5.5 per cent in a little over 18 months).
Consumer spending has been slow to react, partly because so many Kiwis fix their mortgage rates for two years or more, meaning it takes time before they face the reality of rising rates.
And today there are also more older Kiwis with their mortgages paid off or under control. They just aren’t feeling the same pain.
Stuart Baxter, general manager of analytics at credit data company Centrix, sees it in the numbers.
“Where that greatest exposure is, is in that age group from 30-44. That particular segment is where a lot of the first home buyers will be. There will be a few investors, but the majority will be owner-occupiers in their first or second homes,” he says.
“In terms of the pain or the concern, it’s that many of those buyers will have bought at the peak of the property market in 2020 and 2021.”
Centrix data shows that the age group with the highest nominal mortgage right now is between 33 and 41 years old, with an average mortgage above $600,000.
That’s at least an extra $6000 a year they have to find for every percentage point increase in their rate — and there will be many dealing with much bigger numbers than that.
Interest rates were at record low levels back in 2020-21, and many of those borrowers are now being re-priced onto rates that are higher than the rates at which the banks “stress-tested” the levels they could afford, Baxter says.
“These are people who took out a large loan, probably at about 2 or 3 per cent interest and they are now rolling off and being repriced with a six or seven in front of it.”
Matt Goodson, managing director at Salt Funds Management, has noticed the impact flowing through corporate results.
“We’ve seen a really uneven result season from retailers, which reflects some of the cost of living pressures and the cost of rates on the mid-20s to late-40s demographic.”
We are clearly seeing the high mortgage rate pressures come through now, he says.
“But it’s not happening on an even basis and some of the travel companies are reporting very strong numbers.”
Goodson highlights recent Australian research by banking group CBA, which shows how spending by older age groups has continued to rise in the past few months.
In other words, younger generations are being forced to slash spending and hunker down to keep up with mortgage payments, while, Mum and Dad are off to Europe, with their savings sitting in the bank earning a nice deposit rate.
“The biggest error central banks made is they took rates to zero and said they’ll stay zero for several years — trust us, we know what we’re doing,” says Goodson.
“So a lot of people went into the housing market on exceedingly low rates expecting them to stay there and of course they didn’t.
“Those younger borrowers have only experienced a cycle that has been fairly benign. They have no active experience in a high-interest-rate environment. I know by the end of the year, the vast majority will be on a much higher rate.”
“We expect mortgage arrears to continue to rise through the remainder of this year into next,” says Centrix’s Baxter.
The data currently shows that about 1.3 per cent of mortgage holders are in arrears. That is a steep rise over the past year but off a very low base. It is still below pre-Covid levels of arrears.
But the top-line data also reflects increasing numbers of older people who have their mortgages under control.
“In terms of mortgages, we definitely see the older demographic much more able to meet their mortgage obligations,” Baxter says.
“It’s the 30s to mid-40s where we see the highest level of arrears on the mortgages.”
Even Reserve Bank governor Adrian Orr — the man putting the rates up — concedes that there is an uneven distribution of monetary policy pain.
That knowledge weighs heavily, he said in a recent interview for the Herald’s Markets with Madison video show.
But Orr is adamant inflation is the greater evil right now.
“I would feel bad about it if I didn’t think it was for the long-term benefit of the country,” he said. “There are no winners from inflation. Inflation is the big evil, not higher nominal interest rates.”
Orr is also not convinced the uneven nature of the pain is all about age.
“There are some people who feel the burden of monetary policy more than others and it’s not necessarily just a demographic issue,” he said.
“Young people may have less debt to begin with, as an example. But it’s without doubt it impacts, in a relative sense, unevenly across the economy.”
The pain would also be acute right now in agriculture and construction, he said.
“You know, the thing that really destroys the futures of young people is high and variable inflation. Because what do you do with your money?
“I’d like to remind you as well that it’s not just people who have borrowed who are impacted. It’s people who are sitting around making investment decisions. You know, there’s now a high hurdle rate to investing. So that’s a big part of business, and there are people who are saving. They’re now getting rewarded better for saving,” said Orr.
“And likewise, I’d hope that some of the young people have seen that. The housing market is good if you want to live in a house. It’s not your only investment option.”
Hopefully, mortgage rates have peaked. Hopefully, we’ll see inflation keep falling — and interest rates follow.
But longer term, monetary policy faces a structural issue.
As the population ages, the proportion of homeowners carrying a high debt load is dwindling.
The number of people aged 65-plus will reach 1 million by 2028, 1.3 million around 2040, and 1.5 million by the 2050s, according to Stats NZ.
Both the average mortgage size and the percentage of the population with a mortgage fall away fast in the 60-plus age groups.
As the population ages, monetary policy will take longer to bite and central banks may have to lean harder than they might have in the past to beat inflation cycles.
Older people are also typically savers, not spenders.
A 2019 study, How Does Population Aging Affect the Effectiveness of Monetary Policy and Fiscal Policies? by Naoyuki Yoshino and Hiroaki Miyamoto looked at the trend in one of the world’s most aged populations, Japan.
The research, done for the Asian Development Bank, drew a clear conclusion: “Population aging weakens the effectiveness of the monetary policy on the economy. In particular, the positive impact of the monetary policy shock on consumption is weakened in an aging economy. This is because the proportion of the working population who are positively affected by the expansionary monetary policy shock decreases,” the research paper said.
A Yale study in 2015 drew the same conclusion.
Population Aging and the Transmission of Monetary Policy to Consumption, by Arlene Wong, examined the implications of population ageing by considering two economies: Florida and California.
It also concluded that young people are more responsive than older individuals to interest rate shocks.
“The consumption elasticities of young people are significantly larger than that of the average person, and drive most of the aggregate response,” Wong said.
“These results imply that population aging can significantly dampen the transmission of monetary policy to aggregate consumption.”
How will we beat inflation in the future?
The trend suggests we might need to see central bankers do some creative thinking in the decades ahead.
For example, former Reserve Bank governor Don Brash recently suggested that the Reserve Bank could be empowered to tackle inflation by lifting fuel taxes as a way to smooth the pain points.
But that would be a big step away from orthodox policy.
The case could be made that this is really just fiscal policy — the job of governments, not central banks.
There’s a strong case to be made that the current Government could have done more to make the Reserve Bank’s job easier, by tightening spending to push back harder against inflation.
In the future, governments may have no choice.
We should also acknowledge that there are some balancing forces that could keep the issue at bay.
In theory, the inflation problem just shouldn’t be as bad with an older population.
The same demographic forces that weaken the influence of interest rates (lower consumption and higher saving) will also apply more disinflationary pressure to the economy — as has happened in Japan.
But against that, we’re also going to see fewer workers to meet the needs of the older population. That might result in higher wage inflation, and with it price inflation.
And whichever way the long-term trends break, there will still be global supply shocks, things like wars and pandemics that push up food and supply chain costs and cause inflation spikes.
Those kinds of events will require a monetary policy response.
Millennials may yet get their chance to annoy their children with war stories about the bad old days of high interest rates.
It seems there’s no obvious fix on the horizon for the generational pain game.
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.