Good news! Interest rates are on their way down again.

We needed to have a monetary squeeze to deal with our post-COVID burst of inflation but now we’ve largely come through it. Inflation’s back down to target levels on both sides of the Tasman.

The RBA started easing in February, with its first rate cut (from 4.35% to 4.1%). Barring any further global financial market ructions, the financial market gurus expect a clatter of further reductions. The RBNZ is further advanced, with the peak official cash rate of 5.5% already down to 3.5% and again, fingers crossed, there are further cuts to come.

It’s been tough; less so in Australia which seems to have achieved a rare example of the proverbial ‘soft landing’, more so in New Zealand which has been in a rolling recession. But we’re getting there and families with mortgages, business owners with bank loans and treasurers with government bonds to service will be relieved.

At the same time, I wonder if the move back to more normal interest rates and better times will reignite two of our tougher and as yet unresolved economic issues?

Housing heats up

The first is, as lower mortgage rates progressively enable households to tank up on debt again, will we see housing becoming even more unaffordable?

We know that, in Australia, the latest (November 2024) ANZ/CoreLogic Housing Affordability Report found that the ratio of the median house price to the median income is close to an all-time high, at 8.0 times income (9.8 times in Sydney).

In New Zealand, the affordability data calculated by interest.co.nz shows that the price-to-income ratio (calculated a bit differently) is currently 6.5 times income, fortunately down from the crazy 9.3 times income it reached thanks to ultra-low mortgage rates in the COVID era, but still at expensive levels by historical standards.

The risk is that households will be off to the races again.

As well as aggravating one of our bigger social problems, it risks further distorting the supply of credit to more productive purposes. In February, for example, there was A$87 billion of new housing lending in Australia to owner occupiers and investors. That dwarfed the A$14 billion of new fixed-term lending to small businesses and the A$28 billion of new lending to medium-sized businesses. That’s not a good result.

Both Australia and New Zealand have been struggling to generate higher productivity and we need to see substantially increased investment by businesses in capital equipment: more gear makes employees more productive.

So far, there’s only been tinkering around the edges of the next potential upleg in house prices. There have been fringe attempts to restrain demand, such as bans on foreign buying of houses. In reality, only a very significant deregulation of the planning impediments to housing supply will do the trick.

Auckland’s experiment with liberalised housing densification is getting quite a bit of attention. Maybe similar YIMBY (yes in my backyard) initiatives will gain some traction elsewhere, but the more likely bet is that lower interest rates will once again ratchet up already stressed housing markets and prolong the distortions they bring.

Pressures on government debt

The other unaddressed big issue we’ll be revisiting is the problem facing the public finances.

‘What problem?’, you might ask. At first glance, it looks as if the exchequers on both sides of the Tasman are travelling along quite cosily.

In Australia, for example, the Pre-election Economic and Fiscal Outlook update showed modest expected fiscal deficits out to 2028–2029. In 2028–2029, revenue will be 25.3% of GDP, the same as it is today, and spending will be 26.4%, again almost the same as today. Funding the series of deficits over that period will see gross government debt rise from 33.7% of GDP in 2024–2025 to 36.8% in 2028–2029. All very responsible: nobody knows for sure how much debt is too much but whatever it is, Australia is well below it.

New Zealand’s in pretty decent shape, too. On its preferred measure, in its latest Half-Year Economic and Fiscal Update the government expects gradually narrowing fiscal deficits and even a small (0.4% of GDP) surplus by 2028–2029, thanks to expenditure coming down a bit and revenues increasing a bit. The deficits in the interim will take gross debt up to 52.0% of GDP from an estimated 48.3% now but again, that’s well within the safety zone.

Both countries look to be running prudent policies when some others aren’t. Look, for example, at the fiscal folly in the US, which is currently running a fiscal deficit of 6% of GDP.

The latest estimates by its non-partisan Congressional Budget Office show that if policies don’t turn sensible soon, America’s debt will head for doom-loop levels of 156% of GDP by 2055. Our government debt levels stand comparison with many of our developed economy comparator (see below graph from the – free and easy to use – IMF World Economic Outlook database).  

So, if we look so sensible, what’s the issue?

It’s that both governments think, wrongly, that they can keep government spending as a share of the economy at, or below current levels. That might be feasible for the next few years, but it’s implausible beyond that due to demographic issues (ageing in particular), cost pressures for the likes of medical treatments, and the need to decarbonise energy sources and address other infrastructure deficits.

Keeping debt at moderate levels is sensible but that leaves only two other options. One is to hack into some parts of current public spending to pay for the parts that will need more money: call it the ‘austerity’ option. That’s not attractive, as the UK’s example vividly shows. The other is to raise taxes, which is the route I’d personally reach for.

The best time to start the ball rolling on tough policy calls is now, when we look to be heading into better economic conditions. Let’s start those conversations, before our attention gets diverted by whatever crises nature – or the Trump administration – send our way.