MPC heterogeneity and the dynamic response of consumption to monetary policy

Summary

Focus

We study how household financial choices affect the impact of monetary policy on consumption. We use household-level survey data from Germany, France, Italy and Spain to estimate a model of how households allocate their income between savings (in risky and risk-free assets) and consumption. From our model, we derive marginal propensities to consume (MPCs), ie how much a household consumes out of an extra euro received. We use these MPCs to quantify the effect of a change in interest rates on consumption for each household.

Contribution

Understanding the response of consumption to monetary policy is critical for central banks. Our paper uses a new methodology which lets us estimate the effect of interest rate changes on consumption for individual households in a realistic way. Moreover, we can separate the effect into the part that comes from the impact of interest rates changes on employment (income channel) and the part that comes from the impact of interest rates changes on stock prices (stock return channel).

Findings

We find that the effects of monetary policy on consumption depend on a household's income. Income-poor households respond more to changes in interest rates through the income channel. Income-rich households are more likely to participate in stock markets and to respond more to changes in interest rates through the stock return channel. Overall, the effect of monetary policy is stronger for households at both ends of the income distribution in Germany and France, and for income-poor households in Italy and Spain.

Abstract

This paper studies how household financial choices affect the impact of monetary policy on consumption. Based on micro data from four major euro area countries, we estimate structural parameters to match moments related to asset market participation rates, portfolio shares and wealth-to-income ratios by education and country. The country specific distributions of the marginal propensity to consume out of income and financial wealth are not degenerate, reflecting, among other factors, costs to both asset market participation and portfolio adjustment. Due to the heterogeneity in consumption responses, monetary policy, operating through its effects on household income and asset market returns, has a differential impact on individuals within and across countries. Generally, poor households respond more to the income variations produced by monetary policy innovations while rich households respond more to policy-induced variations in stock returns. Monetary policy has a larger impact on consumption in Italy and Spain compared to France and Germany. An extension of the model linking mortgage payments to monetary policy strengthens these findings.

JEL classification: E21, E52

Keywords: heterogeneity, marginal propensity to consume, monetary policy