This week, the Reserve Bank of Australia (RBA) paused on recent interest rate cuts after its sharpest tightening cycle in decades. Now, the economy finds itself in a strange position with inflation remaining stubborn and the labour market softening, but households proving remarkably resilient. Does this mean the economy has become less sensitive to monetary policy, or that rate changes now take longer and have more uncertain effects?
The RBA engaged in one of the biggest tightening cycles in history when it lifted the cash rate by 4.25 percentage points over 2022 and 2023. At the time, it seemed reasonable to expect that households would pull back on spending in response. After all, Australians are among the world’s most indebted households and overwhelmingly borrow on variable-rate mortgages. This means that rate hikes usually pass through quickly to required mortgage payments and cash flow. Conventional wisdom would suggest that soaring mortgage costs would therefore significantly crimp household spending.
But household spending barely flinched. Consumption slowed slightly, but the feared “mortgage cliff” never arrived. Even borrowers facing higher mortgage repayments of around $1,000 a month largely maintained their spending habits.
In a recent e61 working paper with Matt Elias (e61 and University of Chicago), Christian Gillizer (University of Sydney), Greg Kaplan (e61 and University of Chicago) and Nalini Prasad (University of New South Wales) we use aggregated, consented and de-identified bank transaction data from a third-party data provider to compare borrowers with variable-rate loans (whose repayments jumped as rates rose) with those on fixed-rate loans (whose repayments were unchanged). This comparison is intended to isolate the effect of higher mortgage repayments on spending.
We find that despite a sharp rise in required repayments, variable-rate borrowers spent just as much as those on fixed loans. Over 18 months, their mortgage payments rose by about $14,000 on average, yet their monthly spending barely moved.
Roughly 70 per cent of that increase in repayments was financed from savings held in offset and redraw accounts, with most of the rest coming from other funds. In other words, households dipped into buffers they had built up during the pandemic, rather than cutting consumption. Those savings absorbed the shock, letting many households preserve their lifestyles despite higher interest costs.
Why were those buffers so large? Australia’s mortgage market is unusually flexible. Offset and redraw accounts let borrowers pre-pay loans and withdraw the extra funds later with little penalty – essentially turning their mortgage into a high-return, tax-free, liquid savings account. During the pandemic, when spending options were limited, uncertainty was elevated and government support was generous, households channelled record savings into these accounts.
At its pandemic peak, the household sector saved close to 5 per cent of disposable income through scheduled and excess mortgage payments. When rates rose, that “rainy day” saving became a ready-made cushion. Borrowers could trim extra repayments or draw down balances to meet higher costs without cutting spending.
These patterns challenge the standard model of how monetary policy works through the borrower cash flow channel. Traditionally, higher interest rates squeeze cash flow and dampen demand, especially in economies dominated by variable-rate mortgages. But Australia’s experience shows that when mortgage flexibility and large savings buffers are in play, the transmission of monetary policy may become weaker and slower.
During the rate-hike cycle, only about 7 per cent of variable-rate borrowers were liquidity-constrained according to household survey data. With savings plentiful, the RBA’s tightening took longer to bite.
With interest rates falling through 2025, some important features of the Australian mortgage market may again soften the intended effect of increasing consumer spending. Even though interest payments have fallen for variable-rate borrowers, many have not automatically lowered their scheduled payments. Most Australian banks require customers to call and request a lower instalment, and bank-level evidence indicates that only around 10 per cent of borrowers have done so during the 2025 interest rate reductions. Instead, they are rebuilding buffers by paying off loans faster. That means rate cuts may deliver less of an immediate boost to spending than textbook models would predict.
In short, the borrower cash flow channel of monetary policy may have weakened in both directions. The resilience that helped households weather higher rates may also dull the stimulus from lower ones.
Australia’s experience underscores that the potency of monetary policy depends on both sides of the household balance sheet – debt and assets – and not just how interest-sensitive they are but how liquid they are. With flexible mortgage features and substantial buffers, many borrowers can smooth through rate changes rather than respond to them. In today’s economy, mortgage liquidity buffers are the hidden shock absorbers that can shape how and when monetary policy takes effect.
That does not mean that monetary policy has lost its power altogether – just that the channels are shifting, as they have done before. With housing prices rising and wealth effects returning, balance sheet strength rather than cash flow pressure may once again drive the response to interest rate moves.
