Current debt levels spell an end to our rosy economic outlook says expert

Date: 06/04/2005

While Australian households expel a collective sigh of relief over the Reserve Bank's decision not to lift official interest rates, a leading expert from the University of Western Sydney has warned that our current debt levels have reached alarming levels.

Associate Professor Steve Keen from the School of Economics and Finance is a professional sceptic of accepted economic wisdom and has earned a reputation as one of the world's leading critics of conventional economics.

Associate Professor Keen believes Australia's current debt levels are weakening our economy and could force us into a long-term recession.

"My views on current debt levels are based upon a hypothesis known as the Minsky Law which says that debt servicing expands to consume the available income," says Associate Professor Keen.

"People borrow money to finance investment in good times, but because of the cyclical nature of the economy they have to repay that debt in both good times and bad.

"The problem is that people tend to take on more debt than they can handle if their rosy boom time expectations aren't maintained. When the boom comes to an end, it's made doubly bad by the debt overhang."

"As the economy starts to crawl out of a slump, the economic recovery - combined with people being temporarily more prudent about debt - means that debt levels fall back a bit."

"But over time they ratchet up again since each time people think -'oh we survived last time with high debt levels - maybe we underestimated our ability to finance debt, hey we can afford to take on more this time!' "

Associate Professor Keen says that if we begin to look at Australia's debt levels historically, it's obvious that this process has been at work for the past 55 years.

"Debt levels within Australian households have been on the increase since the early 1950s, when for historical reasons such as the Great Depression and the Second World War, the levels were extremely low.

"The real cause for concern is the fact that the level of debt in Australian households has now reached ranges never witnessed before in this country."

Associate Professor Keen says household debt now stands at over 160 per cent of household income.

"When you consider that in 1960 the level was around 40 per cent you begin to understand the massive increase," he says.

"The great danger for the economy is that when debt levels get so high via this process they can then force the economy into a prolonged slump."

Associate Professor Keen says while we could survive a downturn like we did after the 1987-89 bubble burst, equally there's a chance we could find ourselves stuck in the same slump Japan found itself in for the last 15 years, following the collapse of its 'Bubble Economy' at the end of the 1980s.

"In my view it may well be that our debt levels have reached a point of no return for the economy," says Associate Professor Keen.

"And for a key indicator we need look no further than the fact that tiny increases in official interest rates have caused the most recent housing bubble to deflate showing how fragile our current financial system is now."