IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper

Long-term interest rates, wealth and consumption

  • Roy Cromb
  • Emilio Fernandez-Corugedo
Registered author(s):

    This paper examines the sensitivity of the level of consumption to interest rates in a standard partial equilibrium theoretical framework with no uncertainty. Using a multi-period framework, the consumption function is derived and interest rate effects are decomposed into substitution, income and wealth effects. Drawing on parallels with the finance literature, the paper illustrates two key implications of the theory that are not typically emphasised in the economics literature. First, it shows that wealth effects mean that consumption is much more likely to be negatively related to interest rates than the simple two-period textbook model might suggest. Second, it demonstrates that long-term interest rates are more important than short-term rates - the sensitivity of consumption to interest rate changes depends crucially on how long these are expected to persist. Numerical calibrations provide an indication of the sensitivity of the results to key parameters.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2004/WP243long.pdf
    Download Restriction: no

    Paper provided by Bank of England in its series Bank of England working papers with number 243.

    as
    in new window

    Length:
    Date of creation: Nov 2004
    Date of revision:
    Handle: RePEc:boe:boeewp:243
    Contact details of provider: Postal:
    Bank of England, Threadneedle Street, London, EC2R 8AH

    Phone: +44 (0)171 601 4030
    Fax: +44 (0)171 601 5196
    Web page: http://www.bankofengland.co.uk/
    Email:


    More information through EDIRC

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as in new window
    1. Christopher D Carroll, 2000. "Solving Consumption Models with Multiplicative Habits," Economics Working Paper Archive 421, The Johns Hopkins University,Department of Economics.
    2. repec:fth:harver:1435 is not listed on IDEAS
    3. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
    4. Martin Browning & Annamaria Lusardi, 1995. "Household Saving: Micro Theories and Micro Facts," Department of Economics Working Papers 1995-02, McMaster University.
    5. Gourinchas, P.O. & Parker, J.A., 1997. "Consumption Over the Life Cycle," Working papers 9722, Wisconsin Madison - Social Systems.
    6. Jody Overland & Christopher D. Carroll & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June.
    7. Bennett T. McCallum & Edward Nelson, 1997. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," NBER Working Papers 5875, National Bureau of Economic Research, Inc.
    8. Andrew B. Abel, . "Asset Prices Under Habit Formation and Catching Up With the Jones," Rodney L. White Center for Financial Research Working Papers 01-90, Wharton School Rodney L. White Center for Financial Research.
    9. Zeldes, Stephen P, 1989. "Consumption and Liquidity Constraints: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 97(2), pages 305-46, April.
    10. Douglas W. Elmendorf, 1996. "The effect of interest-rate changes on household saving and consumption: a survey," Finance and Economics Discussion Series 96-27, Board of Governors of the Federal Reserve System (U.S.).
    11. Summers, Lawrence H, 1981. "Capital Taxation and Accumulation in a Life Cycle Growth Model," American Economic Review, American Economic Association, vol. 71(4), pages 533-44, September.
    12. Ben S. Bernanke & Vincent R. Reinhart, 2004. "Conducting Monetary Policy at Very Low Short-Term Interest Rates," American Economic Review, American Economic Association, vol. 94(2), pages 85-90, May.
    13. Buiter, Willem H., 2003. "Deflation: Prevention and Cure," CEPR Discussion Papers 3869, C.E.P.R. Discussion Papers.
    14. Christopher D. Carroll & Miles S. Kimball, 1995. "On the concavity of the consumption function," Finance and Economics Discussion Series 95-10, Board of Governors of the Federal Reserve System (U.S.).
    15. Robert E. Hall, 1981. "Intertemporal Substitution in Consumption," NBER Working Papers 0720, National Bureau of Economic Research, Inc.
    16. Lawrance, Emily C, 1991. "Poverty and the Rate of Time Preference: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 54-77, February.
    17. Mojon, Benoît & Kashyap, Anil K. & Angeloni, Ignazio & Terlizzese, Daniele, 2002. "Monetary Transmission in the Euro Area : Where Do We Stand?," Working Paper Series 0114, European Central Bank.
    18. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
    19. Lettau, Martin & Ludvigson, Sydney, 1999. "Consumption, Aggregate Wealth and Expected Stock Returns," CEPR Discussion Papers 2223, C.E.P.R. Discussion Papers.
    20. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    21. Runkle, David E., 1991. "Liquidity constraints and the permanent-income hypothesis : Evidence from panel data," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 73-98, February.
    22. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
    23. Stephen Millard & John Power, 2004. "The effects of stock market movements on consumption and investment: does the shock matter?," Bank of England working papers 236, Bank of England.
    24. Gali, J., 1992. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice and Asset Prices," Papers 92-22, Columbia - Graduate School of Business.
    25. Robert G. King, 2000. "The new IS-LM model : language, logic, and limits," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 45-103.
    26. Christopher D. Carroll & Jody Overland & David N. Weil, 1997. "Comparison Utility in a Growth Model," NBER Working Papers 6138, National Bureau of Economic Research, Inc.
    27. Orazio P. Attanasio & Guglielmo Weber, 1993. "Consumption Growth, the Interest Rate and Aggregation," Review of Economic Studies, Oxford University Press, vol. 60(3), pages 631-649.
    28. Christopher D. Carroll, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 1-55.
    29. Muellbauer, John, 1986. "Habits, Rationality and Myopia in the Life-Cycle Consumption Function," CEPR Discussion Papers 112, C.E.P.R. Discussion Papers.
    30. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
    31. Robert G. King & Sergio T. Rebelo, 2000. "Resuscitating Real Business Cycles," RCER Working Papers 467, University of Rochester - Center for Economic Research (RCER).
    32. Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 974-1009, October.
    33. Emilio Fernandez-Corugedo & Simon Price & Andrew Blake, 2003. "The dynamics of consumers' expenditure: the UK consumption ECM redux," Bank of England working papers 204, Bank of England.
    34. Stephen P Millard & Simon J Wells, 2003. "The role of asset prices in transmitting monetary and other shocks," Bank of England working papers 188, Bank of England.
    35. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
    36. Carl D. Lantz & Pierre-Daniel G. Sarte, 2001. "Consumption, savings, and the meaning of the wealth effect in general equilibrium," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 53-71.
    37. Fagan, Gabriel & Henry, Jérôme & Mestre, Ricardo, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series 0042, European Central Bank.
    38. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:boe:boeewp:243. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Digital Media Team)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.