The Effect of Interest Rate Changes on Consumption: An Age-Structured Approach

Roman Kozlov ()
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Roman Kozlov: Department of Business and Management Science, Norwegian School of Economics, Helleveien 30, 5045 Bergen, Norway

Economies, 2023, vol. 11, issue 1, 1-25

Abstract: Interest rates have generally trended downward over the past several decades. It has made borrowing cheaper, which has encouraged people to spend more. It has also made saving less attractive, contributing to increased consumption. At the same time, the role of household credit increased significantly. The paper suggests a model for the effect of an interest rate change on household consumption, which relies on income and loans. The model is based on methods of the optimal control theory. The approach is age-structured: households reconsider their consumption patterns at the moment of the interest rate change and the changes in consumption patterns are age dependent. The consumption changes for different age groups contribute to the modification of aggregate consumption. Numerical simulation shows that a decrease in the interest rate leads to a consumption boost (a substantial increase in consumption in the short run), which diminishes as time passes and consumption becomes fully adjusted to the new interest rate value. The consumption boost is achieved by an increase in the debt load.

Keywords: interest rate change; consumption; aggregate consumption; debt load (search for similar items in EconPapers)
JEL-codes: E F I J O Q (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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