Lumpy Durable Consumption Demand and the Limited Ammunition of Monetary Policy

In a fixed-cost model of durable consumption demand, we show that an important channel of monetary policy transmission is to prompt households to accelerate the timing of their adjustments. We highlight three ways in which the power of monetary policy is reduced relative to the standard New Keynesian model. First, there is an intertemporal trade-off in aggregate demand as encouraging households to adjust today leaves fewer households acquiring durables going forward. Second, households make a short-term decision—adjusting now rather than in the near future—so the short-term real interest rate is the opportunity cost of adjusting today. As a result, forward guidance is less effective at shifting aggregate demand than contemporaneous interest rate cuts. Third, monetary policy becomes less powerful in a recession. The literature has debated whether fixed-cost models generate state dependence in general equilibrium; we show that if one conditions on the magnitude of the recession, the model's state dependence is unaffected by general equilibrium attenuation.