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

Roine Vestman, Matilda Kilström, Josef Sigurdsson and Martin Flodén
Additional contact information
Matilda Kilström: Stockholm University
Josef Sigurdsson: Stockholm University

No 1015, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: We study the effect of monetary policy on spending when households hold debt with variable interest rates. When interest rates on outstanding loans vary with the short-term market interest rate, monetary policy has a direct and immediate effect on households' expenses and disposable income. If households are borrowing constrained, they will respond to a shock to disposable income by adjusting their spending. As a result, a monetary policy-induced interest rate change leads to a larger change in consumption than what is predicted by the elasticity of intertemporal substitution. We examine this income channel of monetary policy using administrative data on Swedish households. We estimate a strong and statistically significant response in consumption to increases in interest expenses. Highly indebted households with fully adjustable interest-rate loans, such as adjustable rate mortgages, reduce consumption growth by 4 to 5 percentage points in response to a one percentage point increase in the household interest rate. Less indebted households, who are less likely to be borrowing constrained, reduce consumption by much less. Our findings imply that the monetary policy will have a stronger affect on real economic activity when households are highly indebted and have adjustable rate mortgages.

Date: 2016
New Economics Papers: this item is included in nep-mon
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Citations: View citations in EconPapers (8)

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Related works:
Journal Article: Household Debt and Monetary Policy: Revealing the Cash-Flow Channel (2021)
Working Paper: Household Debt and Monetary Policy: Revealing the Cash-Flow Channel (2017)
Working Paper: Household Debt and Monetary Policy: Revealing the Cash-Flow Channel (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:1015

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