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

45 Pages Posted: 16 Mar 2016 Last revised: 17 Nov 2016

Martin Flodén

Sveriges Riksbank; Stockholm University; Centre for Economic Policy Research (CEPR)

Matilda Kilström

Stockholm University - Institute for International Economic Studies (IIES)

Josef Sigurdsson

IIES, Stockholm University

Roine Vestman

Stockholm University - Department of Economics; Swedish House of Finance

Date Written: November 16, 2016

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 cash-flow channel of monetary policy using administrative data on Swedish households. We estimate a strong and statistically significant response in spending to changes in interest expenses. More specifically, we estimate a marginal propensity to consume (including durable consumption) that is around unity or even higher in response to monetary-policy induced changes in interest expenses. For example, highly indebted households with adjustable rate mortgages reduce consumption growth by several percentage points more in response to a one percentage point increase in the household interest rate than households with little debt or fixed rate mortgages. Our findings imply that monetary policy will have a stronger effect on real economic activity when households are highly indebted and have adjustable rate mortgages.

Keywords: Monetary policy, consumption, household debt, variable interest rates, adjustable rate mortgages

JEL Classification: D14, E21, E52, G11

Suggested Citation

Flodén, Martin and Kilström, Matilda and Sigurdsson, Josef and Vestman, Roine, Household Debt and Monetary Policy: Revealing the Cash-Flow Channel (November 16, 2016). Swedish House of Finance Research Paper No. 16-8. Available at SSRN: https://ssrn.com/abstract=2748232

Martin Flodén

Sveriges Riksbank ( email )

Brunkebergstorg 11
SE-103 37 Stockholm
Sweden

HOME PAGE: http://www.martinfloden.net

Stockholm University ( email )

Universitetsvägen 10
Stockholm, Stockholm SE-106 91
Sweden

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Matilda Kilström

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden

Josef Sigurdsson

IIES, Stockholm University ( email )

Stockholm, SE-10691
Sweden

HOME PAGE: http://josefsigurdsson.com

Roine Vestman (Contact Author)

Stockholm University - Department of Economics ( email )

S-10691 Stockholm
Sweden

HOME PAGE: http://www.ne.su.se/

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

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