Household Debt and Monetary Policy: Revealing the Cash-Flow Channel
Paper titled "Household Debt and Monetary Policy: Revealing the Cash-Flow Channel" Martin Flodén, Matilda Kilström, Jósef Sigurdsson, Roine Vestman has been published in The Economic Journal in May.
We examine the effect of monetary policy on household spending when households are indebted and interest rates on outstanding loans are linked to short-term interest rates. Using administrative data on balance sheets and consumption expenditure of Swedish households, we reveal the cash-flow transmission channel of monetary policy. On average, indebted households reduce consumption spending by an additional 0.23–0.55 percentage points in response to a one-percentage-point increase in the policy rate, relative to a household with no debt. We show that these responses are driven by households that have some or a large share of their debt in contracts where interest rates vary with short-term interest rates, such as adjustable-rate mortgages (ARMs), which implies that monetary policy shocks are quickly passed through to interest expenses.