Consumption and Portfolio Rebalancing Response of Households to Monetary Policy

Abstract

Using micro-level administrative data from India, we show the consumption and portfolio rebalancing response of households to changes in interest rate. Exploiting variation in the timing of expiry of term deposits, we find that when interest rate falls, households increase consumption by 6 percent and increase their fraction of wealth into risky assets by 36 percent after the expiry of term deposits. While both existing and new investors “reach for income” by investing in high dividend stocks, new investors also “reach for yield” by investing in high beta and more volatile stocks. The effects on consumption and risky investment are smaller for term depositors with automatic renewal. Households with more liquid wealth have a smaller consumption effect but a larger portfolio rebalancing effect on risky investment. These results highlight that term deposits contract rigidity and household wealth affects the monetary policy pass-through.

Keywords: Monetary Policy, Consumption, Portfolio Rebalancing, Household Finance, Reach for Yield, Reach for Income

JEL Classification: D12, D14, D91, E21, E22, E52, G21, G50