Monetary Policy when Households have Debt: New Evidence on the Transmission Mechanism

Abstract

Using household survey data for the U.S. and the U.K., we show that the aggregate response of consumption to interest rate changes is driven by households with a mortgage. Outright home-owners do not adjust expenditure at all while renters change their spending but by less than mortgagors. Income rises for all households as interest rate cuts directly affect firm investment and household consumption, boosting aggregate demand. A crucial difference between the housing tenure groups is the composition of their balance sheets: mortgagors hold sizable illiquid assets but little liquid wealth. Our results reveal that general equilibrium effects on household income coupled with balance-sheet-driven heterogeneity in the marginal propensity to consume play a key role in the transmission of monetary policy.

Central Bank Policies and Income and Wealth Inequality: A Survey

“…Quarterly or monthly microdata would allow examining distributional effects of monetary policy at a higher frequency over a long horizon. Longitudinal household surveys have been used to study the impact of monetary policy on inequality, in the USA (Doepke and Schneider, ; Montecino and Epstein, ; Cloyne et al ., , Coibion et al. , ), the UK (Mumtaz and Theophilopoulou, , ; Cloyne et al ., ; Bunn et al ., ), Japan (Saiki and Frost, ; Inui et al ., ), and Italy (Casiraghi et al ., ).…”

“…Other empirical evidence suggests that it is expansionary (and not contractionary) monetary policy that increases income inequality. This is found for the UK, the USA (Cloyne et al ., ), and Japan before the 2000s (Inui et al ., ). Inui et al .…”

“…Cloyne et al . () distinguish income groups based on housing tenure. They find that expansionary monetary policy raises incomes for mortgagors relatively more than for other groups, which could increase inequality.…”

Mortgage Design in an Equilibrium Model of the Housing Market

“…Beraja et al (2019) provide empirical evidence for this hypothesis by analyzing the impact of monetary policy during the Great Recession and study the interaction between monetary policy and mortgage design. Relatedly, several papers argue that ARMs allow for stronger transmission of monetary policy since rate changes directly affect household balance sheets (Calza, Stracca, and Monacelli (2013), Auclert (2019), Cloyne, Ferreira, and Surico (2019)). Garriga, Kydland, and Sustek (2016) provide a model with long-term debt that features a yield curve and is related to our findings about the differential effects of mortgage designs that are priced off the short end relative to the long end of the yield curve.…”

Do demographics affect monetary policy transmission in Canada?

“…Berja, Fuster, Hurst, and Vavra () also find that the consumption spending of households with higher levels of mortgage debt is also more sensitive to interest rate changes in the United States, and Cloyne, Ferreira, and Surico () find the same thing for the United Kingdom and the United States.…”