Monetary Policy When Households Have Debt: New Evidence on the Transmission Mechanism

Abstract

This paper offers a new perspective on the transmission of monetary policy using household data for the U.S. and U.K.. Following a temporary cut in interest rates, households with mortgage debt increase their spending significantly, home-owners without debt do not adjust expenditure at all and renters increase spending but by less than mortgagors. Income, however, rises considerably for all households. We show that the balance sheets of these housing tenure groups differ markedly in their composition of liquid versus illiquid wealth. This heterogeneity in liquidity holdings, together with a sizable general equilibrium effect on income, is crucial for explaining our results. In contrast, differences in demographics, the elasticity of intertemporal substitution, wealth effects and the response of mortgage and rental payments are unable to account for the heterogeneity in expenditure we document.

Differences in Euro-Area Household Finances and their Relevance for Monetary-Policy Transmission

“…Thus, differences in household finances, which change the marginal propensity to consume, also change the consumption responses to price shocks. Auclert (2017), Kaplan et al (2016b) and Wong (2018) have investigated the distribu-tional and aggregate effects of unexpected changes in the nominal interest rate on consumption for the U.S. Cloyne et al (2015) compare the respective consumption responses in the U.S. and the U.K., and Jappelli and Scognamiglio (2018) provide evidence for Italy. We contribute to this literature by analyzing the consumption responses to changes in the interest rate for the euro area.…”

“…A rent-price ratio of 3.5% seems also plausible in our benchmark with stable relative house prices if one considers a user cost for owned housing that equals the sum of the real interest rate of 3% and a depreciation rate of 0.5%. 8 See, for example, Auclert (2017),Berger et al (2017),Beraja et al (2017),Hedlund et al (2016),Kaplan et al (2017) andKaplan et al (2016b) for analyses on the U.S. andCloyne et al (2015) for evidence on the U.S. and the U.K.…”

Household Debt and Monetary Policy: Revealing the Cash-Flow Channel

“…On the other hand, we find that expected changes to the monetary policy rate have a stronger differential impact than unexpected changes which is consistent with outright hand-to-mouth behavior. Our paper contributes to several strands of literature, of which Cloyne et al (2016) is most similar to us. They study the response of expenditure and income to monetary policy in the UK and the US.…”

“…However, they argue that the general equilibrium effect of monetary policy on income is quantitatively more important than the direct effect of cashflows. In contrast to Cloyne et al (2016) we are able to study responses across the distribution of debt positions even among households with the same housing tenure status, and thus shed further light on the mechanisms at work.…”

Large and State-Dependent Effects of Quasi-Random Monetary Experiments

“…In Kaplan, Moll, and Violante (2017), the mechanism operates via the heterogeneity in marginal propensities to consume of households facing uninsurable income shocks in incomplete markets. Narrowing the focus, Iacioviello (2005) and Cloyne, Ferreira, Surico (2015) argue that households' reactions to monetary policy shocks varies depending on variation in levels of mortgage indebtedness. On the firm side, a venerable literature (Bernanke and Gertler, 1995;Kashyap, Lamont, and Stein 1994;and Kashyap and Stein 1995) argued that credit constrained firms are more responsive to monetary policy.…”