How Does a Tight Monetary Policy Shock Affect the Household Sector Intermediation? Evidence from Households’ Flow-of-Funds Data

Does an unexpected tight monetary policy shock induce households to cut the incurrence of liabilities and the acquisition of financial assets? We find that a positive GDP shock leads to an increase in the consumer price level and repo rate. The repo rate increases to curb inflation, consistent with a forward-looking monetary policy conduct that mitigates inflationary pressures. In addition, the household sector net financial asset flow declines due to a tight monetary policy shock. This indicates that households become net borrowers, and this occurs through the revaluation of outstanding debt following a new high interest rate. The worsening of the household net lending position is due to increased liability flows, which indicates more borrowing, possibly to smooth out their obligations and consumptions. From the policymaking perspective, the financial assets flow evidence indicates that households participate in capital markets. The monetary policy tightening shock significantly increases short- and medium-term monetary deposits, which are held for transactional and precautionary purposes. Long-term deposits decline indicating the switching from these assets into short- and medium-term deposits and deposits with other financial institutions. Furthermore, GDP dampens the households’ liability flows possibly by providing employment opportunities that generate income, hence discouraging the household incurrences of liability flows. The results indicate that robust GDP growth is needed to mitigate the high incurrence of liability flows after a policy tightening shock.