A common perception among many academics and policymakers is that monetary policy in advanced economies has been less effective since the crisis because of higher household debt and associated credit constraints (Sufi 2015). To date, however, the issue has – to our knowledge – not been systematically assessed. A few studies have examined the role of household balance sheets in monetary transmission, generally finding that more indebted and less liquid households react more to monetary policy (e.g. Aldangady 2014, Cloyne et al. 2018, Di Maggio et al. 2017, Flodén et al. 2017, Luo 2017). However, these papers have focused on the pre-crisis period, and have not directly analysed whether post-crisis debt levels have impeded transmission. One open question is whether at very high debt levels consumption becomes less reactive to monetary policy shocks, possibly because monetary policy actions do little to ease financing constraints.
In a recent paper (Gelos et al. 2019), we compare the transmission of monetary policy through household consumption in the pre- and post-crisis periods, and ask whether changes therein can be explained by the evolution of household balance sheets. To this end, we use quarterly household-level data from the US Consumer Expenditure Survey (CEX) from 1996 to 2014.
To identify monetary policy shocks in a manner that is suitable for both the pre- and post-crisis periods, we resort to high-frequency changes in two-year bond yields in response to monetary policy announcements (Gürkaynak et al. 2005, 2007, among others). We sum monetary policy surprises from all announcements in a given quarter, as in Romer and Romer (2004), to construct measures consistent with our quarterly data on consumption.
We explore the role of two household balance-sheet variables in driving cross-sectional differences in the responses to monetary policy shocks: indebtedness (mortgage balance relative to house value) and liquidity (liquid assets to monthly income).
The analysis shows that the response of household consumption to monetary policy shocks has diminished since the Global Crisis (Figure 1 and Table 1). This result emerges both when using synthetic cohorts of households to obtain longer time series (households only stay in the CEX data for four quarters) and when exploring the fully disaggregated information at the household level.
Figure 1 Response of durable and non-durable consumption to monetary policy
Source: IMF staff estimates.
Note: GMM estimation, 1996Q1-2014Q4. Dependent variable is the accumulated quarterly growth rate in real consumption. Individual data from CEX are aggregated in 42 synthetic cohorts according to housing status and five-year birth year intervals. In the first stage regression, the two-year yield is instrumented by monetary policy shocks (see Appendix III for a description of these shocks). All regressions include a constant, aggregate macroeconomic controls (inflation and real GDP growth), and quarterly seasonal effects. Standard errors are robust to heteroskedasticity and autocorrelation. Full line shows the estimated effect, while the dotted lines show the 90% confidence interval.
Table 1 Impact of monetary policy on consumption and the role of indebtedness
We also find that more indebted households tend to respond more to monetary policy shocks – particularly when it comes to durable consumption – in the pre- and post-crisis periods. While the effects are non-linear they are not U-shaped, as households with the highest indebtedness respond the most to monetary policy shocks. This suggests that household debt did not contribute to lessening the effects of monetary policy over time, since the distribution of debt did not change markedly with the crisis, while its average even increased somewhat (Figure 2).
Figure 2 Density of indebtedness (loan-to-value ratios)
Similar results hold for household liquidity. Households with lower levels of liquid assets react more strongly to monetary policy shocks, both pre- and post-crisis. Again, because the distribution of liquidity across households remained stable over time (Figure 3), liquidity constraints cannot explain the decline in monetary policy effectiveness. The explanation for the lower effectiveness of monetary policy must therefore lie elsewhere, such as in the higher degree of economic uncertainty brought about by the crisis. We find tentative evidence in favour of this hypothesis – but this is a question that deserves further exploration.
Figure 3 Density of liquid asset to income
Authors’ note: The views expressed are those of the authors and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Aladangady, A (2017), “Housing wealth and consumption: Evidence from geographically-linked microdata”, American Economic Review 107(11): 3415-46.
Cloyne, J, C Ferreira and P Surico (2018), “Monetary policy when households have debt: New evidence on the transmission mechanism”, Documentos de trabajo 1813, Bank of Spain.
Di Maggio, M, A Kermani, B J Keys, T Piskorski, R Ramcharan, A Seru and V Yao (2017), “Interest rate pass-through: Mortgage rates, household consumption, and voluntary deleveraging”, American Economic Review 107(11): 3550-88.
Flodén, M, M Kilström, J Sigurdsson and R Vestman (2017), “Household debt and monetary policy: Revealing the cash-flow channel”, CEPR Discussion Paper 12270.
Gelos, G, F Grinberg, S Khan, T Mancini-Griffoli, M Narita and U Rawat (2019), “Has higher household indebtedness weakened monetary policy transmission?”, IMF working paper 19/11.
Gürkaynak, R S, B P Sack and E T Swanson (2005), “Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements”, International Journal of Central Banking 1(1): 55-93.
Gürkaynak, R S, B P Sack and E T Swanson (2007), “Market-based measures of monetary policy expectations”, Journal of Business & Economic Statistics 25(2): 201-212.
Luo, W (2017), “The consumer credit channel of monetary policy”, PhD dissertation, Georgetown University.
Romer, C D and D H Romer (2004). “A new measure of monetary shocks: Derivation and implications”, American Economic Review 94(4): 1055-1084.
Sufi, A (2015), “Out of many, one? Household debt, redistribution and monetary policy during the economic slump”, Andrew Crockett Memorial Lecture, Bank for International Settlements.