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Household Debt and Monetary Policy: Revealing the Cash-Flow Channel

Author

Listed:
  • Roine Vestman

    (Stockholm University)

  • Matilda Kilström

    (Stockholm University)

  • Josef Sigurdsson

    (Stockholm University)

  • Martin Floden

    (Sveriges Riksbank)

Abstract

We study the effect of monetary policy on spending when households hold debt with variable interest rates. When interest rates on outstanding loans vary with the short-term market interest rate, monetary policy has a direct and immediate effect on households' expenses and disposable income. If households are borrowing constrained, they will respond to a shock to disposable income by adjusting their spending. As a result, a monetary policy-induced interest rate change leads to a larger change in consumption than what is predicted by the elasticity of intertemporal substitution. We examine this income channel of monetary policy using administrative data on Swedish households. We estimate a strong and statistically significant response in consumption to increases in interest expenses. Highly indebted households with fully adjustable interest-rate loans, such as adjustable rate mortgages, reduce consumption growth by 4 to 5 percentage points in response to a one percentage point increase in the household interest rate. Less indebted households, who are less likely to be borrowing constrained, reduce consumption by much less. Our findings imply that the monetary policy will have a stronger affect on real economic activity when households are highly indebted and have adjustable rate mortgages.

Suggested Citation

  • Roine Vestman & Matilda Kilström & Josef Sigurdsson & Martin Floden, 2016. "Household Debt and Monetary Policy: Revealing the Cash-Flow Channel," 2016 Meeting Papers 1015, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:1015
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    Cited by:

    1. Pietrunti, Mario & Signoretti, Federico M., 2020. "Unconventional monetary policy and household debt: The role of cash-flow effects," Journal of Macroeconomics, Elsevier, vol. 64(C).
    2. Serdar Ozkan & Kurt Mitman & Fatih Karahan & Aaron Hedlund, 2016. "Monetary Policy, Heterogeneity and the Housing Channel," 2016 Meeting Papers 663, Society for Economic Dynamics.
    3. Jong Chil Son & Hail Park, 2019. "U.S. Interest Rate and Household Debt Sustainability: The Case of Korea," Sustainability, MDPI, Open Access Journal, vol. 11(14), pages 1-16, July.
    4. Helen Hughson & Gianni La Cava & Paul Ryan & Penelope Smith, 2016. "The Household Cash Flow Channel of Monetary Policy," RBA Bulletin (Print copy discontinued), Reserve Bank of Australia, pages 21-30, September.
    5. James Cloyne & Clodomiro Ferreira & Paolo Surico, 2020. "Monetary Policy when Households have Debt: New Evidence on the Transmission Mechanism," Review of Economic Studies, Oxford University Press, vol. 87(1), pages 102-129.
    6. Jouchi Nakajima, 2018. "The role of household debt heterogeneity on consumption: Evidence from Japanese household data," BIS Working Papers 736, Bank for International Settlements.
    7. Nakajima, Jouchi, 2020. "The role of household debt heterogeneity on consumption: Evidence from Japanese household data," Economic Analysis and Policy, Elsevier, vol. 65(C), pages 186-197.
    8. Sang-yoon Song, 2019. "The Cash-Flow Channel of Monetary Policy: Evidence from Mortgage Borrowers," Working Papers 2019-20, Economic Research Institute, Bank of Korea.
    9. Youngju Kim & Hyunjoon Lim, 2017. "Transmission of Monetary Policy in Times of High Household Debt," Working Papers 2017-35, Economic Research Institute, Bank of Korea.
    10. Slacalek, Jiri & Tristani, Oreste & Violante, Giovanni L., 2020. "Household balance sheet channels of monetary policy: A back of the envelope calculation for the euro area," Journal of Economic Dynamics and Control, Elsevier, vol. 115(C).
    11. Sang-yoon Song, 2020. "Leverage, Hand-to-Mouth Households, and Heterogeneity of the Marginal Propensity to Consume: Evidence from South Korea," Review of Economics of the Household, Springer, vol. 18(4), pages 1213-1244, December.
    12. Fergus Cumming & Paul Hubert, 2019. "The Role of Households' Borrowing Constraints in the Transmission of Monetary Policy This paper investigates how the transmission of monetary policy to the real economy depends on the distribution of ," Documents de Travail de l'OFCE 2019-20, Observatoire Francais des Conjonctures Economiques (OFCE).
    13. Cumming, Fergus & Hubert, Paul, 2019. "The role of households’ borrowing constraints in the transmission of monetary policy," Bank of England working papers 836, Bank of England, revised 06 Jan 2020.
    14. Fergus Cumming, 2019. "Mortgage Cash-flows and Employment," Discussion Papers 1922, Centre for Macroeconomics (CFM).
    15. Kim, Youngju & Lim, Hyunjoon, 2020. "Transmission of monetary policy in times of high household debt," Journal of Macroeconomics, Elsevier, vol. 63(C).
    16. Musa BAYIR, 2020. "The Role of House Prices in the Monetary Transmission Mechanism," Sosyoekonomi Journal, Sosyoekonomi Society, issue 28(45).
    17. Voinea, L. & Lovin, H. & Cojocaru, A., 2018. "The impact of inequality on the transmission of monetary policy," Journal of International Money and Finance, Elsevier, vol. 85(C), pages 236-250.
    18. Gaston G Gelos & Tommaso Mancini Griffoli & Machiko Narita & Federico Grinberg & Umang Rawat & Shujaat Khan, 2019. "Has Higher Household Indebtedness Weakened Monetary Policy Transmission?," IMF Working Papers 2019/011, International Monetary Fund.

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    More about this item

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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