Monetary policy according to households: perceptions, reactions and channels
Summary
Focus
How does news about monetary policy decisions influence households' expectations regarding economic conditions? And how do households adjust their spending decisions and reallocate their financial assets in response to such news?
Contribution
We address these questions by leveraging the results of large-scale household survey conducted in the United States. The survey includes a comprehensive set of questions, asking participants how they would expect economic conditions to evolve following hypothetical changes in the federal funds rate, and how they would adjust their economic decisions. In addition, the survey includes a large number of information treatments, providing respondents with information about specific recent economic conditions – for example, inflation level, unemployment etc – to examine how they would respond to each of these factors.
Findings
The analysis reveals that households reduce spending in response to interest rate hikes, consistent with standard economic theory, though the effect is modest. However, the transmission mechanism differs from traditional theory. Households anticipate that policy rate hikes will increase inflation, as they associate higher borrowing costs with rising prices. In turn, they respond to higher expected inflation by cutting back on spending, possibly as a precaution against higher expected living costs. This highlights the pivotal role of inflation expectations in shaping household responses to monetary policy. In contrast, households do not expect monetary policy to affect their incomes.
Abstract
This paper studies how households perceive the transmission of monetary policy and how these perceptions affect their decisions. Using a large-scale survey of over 25,000 U.S. households combined with randomized information treatments, we measure how households expect changes in the federal funds rate to affect economic conditions and their own behavior. Households report that higher interest rates lead them to reduce their spending, particularly on durable goods. However, the mechanisms underlying this response differ markedly from those in standard macroeconomic models. Respondents expect monetary tightening to raise borrowing costs and inflation. In turn, consumption function estimates identified using information treatments reveal that households respond to higher expected inflation by reducing consumption. Household inflation expectations also emerge as a central driver of portfolio reallocations following monetary policy changes.
JEL classification: E3, E4, E5
Keywords: monetary policy transmission, household expectations, inflation expectations, consumption, portfolio choice, survey evidence
