Consumer Spending and the After-Tax Real Interest Rate

Abstract

This paper examines the interaction between consumer durable goods andconsumer non-durable goods in determining the responsiveness of totalexpenditure to the after-tax real interest rate. The introduction ofconsumer durables into the consumer's decision problem can have importanteffects on the interest elasticity of total spending. The channelhighlighted here might be called the "user cost effect," in that theafter-tax interest rate enters the implicit user cost of consumer durablegoods. Even if a consumer has a one-period planning horizon, possiblybecause of a binding borrowing constraint, the user cost effect maynonetheless make his spending highly interest sensitive. Finally, thepaper examines the response of the level and composition of consumerspending to the high real interest rates experienced in the early 1980s.