Monetary policy when households have debt: new evidence on the transmission mechanism

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 08 April 2016

Working Paper No. 589
By James Cloyne, Clodomiro Ferreira and Paolo Surico

In response to an interest rate change, mortgagors in the United Kingdom and United States adjust their spending significantly (especially on durable goods) but outright home-owners do not. While the dollar change in mortgage payments is nearly three times larger in the United Kingdom than in the United States, these magnitudes are much smaller than the overall change in expenditure. In contrast, the income change is sizable and similar across both household groups and countries. Consistent with the predictions of a simple heterogeneous agents model with credit-constrained households and multi-period fixed-rate debt contracts, our evidence suggests that the general equilibrium effect of monetary policy on income is quantitatively more important than the direct effect on cash flows.

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