Inequality, Monetary Policy and Aggregate Demand

Paper Session

Saturday, Jan. 7, 2017 8:00 AM – 10:00 AM

Hyatt Regency Chicago, McCormick
Hosted By: Econometric Society
  • Chair: Kurt Mitman, IIES-Stockhom University

Inequality and Aggregate Demand

Adrien Auclert
,
Princeton University
Matthew Rognlie
,
Massachusetts Institute of Technology

Abstract

We explore the quantitative effects of transitory and persistent increases in income inequality on equilibrium interest rates and output. Our starting point is a Bewley-Huggett-Aiyagari model featuring rich heterogeneity and earnings dynamics as well as downward nominal wage rigidities. A temporary rise in inequality, if not accommodated by monetary policy, has an immediate effect on output that can be quantified using the empirical covariance between income and marginal propensities to consume. A permanent rise in inequality can lead to a permanent Keynesian recession, which is not fully offset by monetary policy due to a lower bound on interest rates. We show that the magnitude of the real interest rate fall and the severity of the steady-state slump can be approximated by simple formulas involving quantifiable elasticities and shares, together with two parameters that summarize the effect of idiosyncratic uncertainty and real interest rates on aggregate savings. For plausible parametrizations the rise in inequality can push the economy into a liquidity trap and create a deep recession. Capital investment and deficit-financed fiscal policy mitigate the fall in real interest rates and the severity of the slump.

Monetary Policy, Heterogeneity and the Housing Channel

Kurt Mitman
,
IIES-Stockhom University
Aaron Hedlund
,
University of Missouri
Fatih Karahan
,
Federal Reserve Bank of New York
Serdar Ozkan
,
University of Toronto

Abstract

Abstract We investigate the role of housing and mortgage debt in the transmission and effectiveness of monetary policy. First, monetary policy induced-movements in house prices translate into consumption changes because of wealth effects. Second, a contractionary monetary shock raises the cost of borrowing which reduces the demand and as a result the liquidity of the housing market, further depressing house prices and further increases the cost of borrowing. Furthermore, nominal long-term mortgage debt implies that changes in monetary policy result in redistribution between lenders and borrowers and generate cash-flow effects that are larger for borrowing constrained households. We build a heterogenous agent New Keynesian model with a frictional housing market to quantify the various mechanisms. The model is able to match the rich empirical heterogeneity in home ownership, leverage and MPC across households. In particular, our model is consistent with the significant difference in MPC between low- and high-LTV households that we document in the data. Our quantitative findings are as follows: First, we find that about 20% of the drop in aggregate consumption against a contractionary monetary shock is due to declining house prices. Second, we find asymmetric responses of the economy to shocks, with contractionary shocks yielding a larger response of all variables. Finally, we investigate how the transmission of monetary policy depends on the distribution of mortgage debt and find that monetary policy is more effective in stimulating the economy in an high-LTV environment.

Household Debt and Monetary Policy: Revealing the Cash-Flow Channel

Roine Vestman
,
Stockholm University
Martin Floden
,
Sveriges Riksbank
Matilda Kilstrom
,
Stockholm University
Josef Sigurdsson
,
Stockholm University

Abstract

We examine the cash-flow channel of monetary policy, i.e. the effect of monetary policy on spending when households hold debt linked to short-term rates such as adjustable rate mortages (ARMs). Using registry-based data on Swedish households, we estimate substantial responses to a change in the monetary policy rate depending on homeowners' debt-to-income ratio and depending whether homeowners hold ARMs or FRMs. Our findings imply that monetary policy will have a stronger effect on real economic activity when households are highly indebted and have ARMs. For homeowners with a debt-to-income ratio exceeding 2 and who hold ARMs, the response is equivalent to a marginal propensity to consume of 0.5 out of interest expenses.

Monetary Policy When Households Have Debt: New Evidence on the Transmission Mechanism

Paolo Surico
,
London Business School
James Cloyne
,
Bank of England
Clodomiro Ferreira
,
London Business School

Abstract

This paper offers a new perspective on the transmission of monetary pol- icy using household micro-data for the U.S. and U.K.. Following a temporary cut in interest rates, households with mortgage debt increase their spending significantly, home-owners without debt do not adjust expenditure at all and renters increase spending but by less than mortgagors. Income, however, rises considerably for all households. We show that the balance sheets of these hous- ing tenure groups differ markedly in their composition of liquid versus illiquid wealth and this heterogeneity in liquidity holdings, together with a sizable general equilibrium effect on income, is crucial for explaining our results. In contrast, differences in demographics, the elasticity of intertemporal substi- tution, wealth effects and the response of mortgage and rental payments are unable to account for the heterogeneity in expenditure we document.
Discussant(s)
Alisdair McKay
,
Boston University
Ralph Luetticke
,
University of Bonn
Daniel Greenwald
,
New York University
Johannes Friedrich Wieland
,
University of California-San Diego
JEL Classifications
  • D0 - General