Consumption and the interest rate – A changing dynamic?

This article addresses the question of whether the relation between the short interest rate and consumption growth has been stable over the financial crisis and the ensuing period of unconventional monetary policy. The question is addressed by assessing models using constant or drifting parameters as well as models with or without stochastic volatility in a Bayesian VAR framework, based on data from the USA and Sweden. According to the results, the response of interest rates to shocks in consumption growth has decreased for both countries, which could be because the central banks were constrained by the zero lower bound. When shadow rates are used to study the impact of unconventional monetary policy the results suggest that the Federal Reserve successfully maintained an active monetary policy in spite of the zero lower bound. The responsiveness of the Riksbank, on the other hand, decreases in face of the zero lower bound even when unconventional monetary policy is considered. The response of consumption growth to short interest rates is best modelled as constant over the period. Finally, results support the inclusion of stochastic volatility throughout estimations.