Consumer Spending and the After-Tax Real Interest Rate

This paper examines the interaction between consumer durable goods and consumer non-durable goods in determining the responsiveness of total expenditure to the after-tax real interest rate. The introduction of consumer durables into the consumer's decision problem can have important effects on the interest elasticity of total spending. The channel highlighted here might be called the "user cost effect," in that the after-tax interest rate enters the implicit user cost of consumer durable goods. Even if a consumer has a one-period planning horizon, possibly because of a binding borrowing constraint, the user cost effect may nonetheless make his spending highly interest sensitive. Finally, the paper examines the response of the level and composition of consumer spending to the high real interest rates experienced in the early 1980s.