SPEECH
Households and the transmission of monetary
policy
Speech by Philip R. Lane, Member of the Executive Board of the ECB, at the Central Bank of
Ireland/ECB Conference on Household Finance and Consumption
Dublin, 16 December 2019
Introduction
It is a special pleasure to speak at the Sixth Conference on Household Finance and Consumption, which is
jointly organised this year by the Central Bank of Ireland and the European Central Bank.[1]
The engine behind this conference series is the Eurosystem's Household Finance and Consumption
Network, which coordinates the Household Finance and Consumption Survey (HFCS). The HFCS gives us
an insight into the distributions of assets, liabilities and incomes across euro area households. It is very
promising that many of you, together with other researchers, are using this dataset to improve our
understanding of key features of economic behaviour in Europe.
In my remarks today, I wish to discuss the relevance of differences across households for macroeconomic
outcomes and the transmission of monetary policy. Households differ across many dimensions: age,
geography, employment, income, wealth, assets, and debt. It follows that the impact of a macroeconomic
shock or a shift in monetary policy will naturally vary across households. In turn, understanding how
shocks and policies affect different types of households has the potential to improve our modelling of
aggregate dynamics compared with the restrictive approach of imposing that aggregate household
behaviour can be adequately represented by a single, representative household. Moreover, the
examination of household-level data is also important in measuring the distributional impact of
macroeconomic shocks and macro-financial policy decisions, which can help inform wider policy
discussions about income distribution.
Before turning to the microeconomic evidence, a natural starting point is to review the standard
macroeconomic analysis of aggregate consumption dynamics. Chart 1 shows that consumption has
increased steadily in recent years, which lines up with the substantial increase in household incomes due
to rising employment and increasing wages. Another important indicator is consumer confidence, which in
turn relates to how consumers view their personal financial situation and the wider macroeconomic
situation (Chart 2). In addition, households do not only consume, but also contribute to investment in the
form of residential property - both house purchases and renovations (Chart 3).
Chart 1
Households' real disposable income and consumption
Sources: Eurostat and ECB calculations.
Notes: All income components are deflated with the GDP deflator. The contribution from the terms of trade is proxied by
the differential in the GDP and consumption deflator. Consumption and total disposable income are deflated with the
consumption deflator.
Latest observation: Q3 2019 for real consumption and Q2 2019 for the rest.
Chart 2
Euro area consumer confidence
(percentage balances, deviation from mean)
Sources: European Commission and ECB calculations.
Latest observation: November 2019.
Chart 3
Household investment
(year-on-year percentage changes)
Sources: Eurostat and ECB.
Note: The data refer to nominal gross fixed capital formation by households and non-profit institutions serving households.
Latest observation: Q2 2019.
For monetary policy analysis, an important question is the extent to which easier financial conditions have
contributed to these dynamics through a variety of direct and indirect channels. A comprehensive analysis
of this question requires a microeconomic approach, which takes into account relevant differences across
households.[2]
Household-level data, such as those available from the HFCS, are essential for this purpose. These data
highlight some quantitatively-important dimensions of heterogeneity in the euro area, which can be
grouped into two broad categories.
First, the level and volatility of income varies across households according to socio-economic
characteristics such as education, age and occupation.[3]
Households with different income sources (e.g. employees, firm owners, unemployed), different skill levels,
or different labour supply elasticities will respond differently to macroeconomic shocks. In turn, wages vary
strongly with characteristics such as age and education. Such differences not only matter for
understanding how different types of households react differently to economic shocks: evidence suggests
that changes in the composition of the workforce can help explaining euro area wage growth at the
aggregate level.[4]
Estimates for the largest four euro area countries indicate that the increase in income after an
expansionary monetary policy shock is particularly large for households in the lowest income quintile
(Chart 4).[5]
The explanation is that low-income households are substantially more likely to be unemployed at any point
in time: it follows that this group is more likely to benefit from the employment creation triggered by a
monetary expansion. Similarly, the elasticity of labour income in relation to changes in aggregate GDP
growth is significantly higher for workers in lower-income households.[6]
Chart 4
Effect of monetary policy easing on household income by income quintile
(percentages)
Sources: Lenza, M. and Slacalek, J. (2018) op. cit., Eurosystem Household Finance and Consumption Survey, wave 2.
Notes: The chart, taken from Lenza, M. and Slacalek, J. (2018) op. cit, shows the percentage change in mean income
across income quintiles in the euro area four quarters after the impact of a quantitative easing shock, which is assumed to
correspond to a 30 basis point drop in the spread between a 10-year sovereign bond and the policy rate. It also shows the
decomposition of the change into the extensive margin (transition from unemployment to employment) and the intensive
margin (increase in wages). The numbers in brackets show the initial levels of mean gross household income in each
quintile. The statistics cover the euro area, which is modelled here as an aggregate of France, Germany, Italy, and Spain.
Second, households differ substantially in the size and composition of the assets they own and in their
indebtedness (Chart 5). Based on the second wave of the HFCS almost 60 percent of euro area
households are homeowners, of which about a third have a mortgage. Almost all households own financial
assets, even if their value is typically only a small fraction of the value of their real estate holdings.[7]
These dimensions of household heterogeneity clearly matter for the exposure of individual households to
monetary policy decisions.
Chart 5
Household assets and debt by income quintile
(x-axis: quintiles and deciles; y-axis: EUR thousands)
Sources: De Bond, G. et al. (op. cit), and Household Finance and Consumption Survey, results from the second wave.
Notes: The chart shows the average value of assets and debt per household across five income quintiles for the euro
area. The top quintile is further broken down into two deciles. Housing wealth is composed of the households' main
residence and other real estate. Other assets include the value of households' vehicles, voluntary pension/life insurance,
shares, valuables, bonds, managed accounts and money owed to households.
For instance, ECB simulations suggest that unexpectedly-low inflation tends to harm young and
middleaged households, and more so for young income-rich households that disproportionately have nominal
[8]
debt liabilities.
By contrast, older households tend to gain from unexpectedly-low inflation, especially if they are
incomerich, since this group tends to hold nominal assets.[9]
To the extent that their financial assets have short maturities and their mortgages have adjustable rates,
households will also be differently affected by a reduction in the interest rate.[10]
The estimates in Chart 6 show that an average net borrower has gained close to EUR 2,000 per year in
lower interest payments in recent years, whereas an average net saver has lost close to EUR 700 per
year.[11]
Chart 6
Change in net interest income for borrowers and savers in the euro area
(euros per household; change in annual net interest income, 2007-2017)
Sources: Dossche, M. et al. op. cit., using the Household Finance and Consumption Survey (second wave).
Notes: Net borrowers are defined as households with a negative net financial wealth position and net savers are defined
as households with a positive net financial wealth position. Percentages in brackets indicate the share of net borrowers
and net savers in the total household population.
Analogously, only homeowners will benefit from any increase in house prices induced by a monetary policy
easing and those with mortgages will benefit disproportionately due to the impact of leverage. Conversely,
Chart 7 reports estimates of the evolution of household net wealth as a result of the lower house prices
observed in many countries between 2011 and 2014. It suggests that the net wealth of homeowners
declined by 6 percentage points more than the wealth of renters. The decline was especially marked for
homeowners with mortgages, for whom it amounted to as much as around 20 percent.
Chart 7
Growth of median net wealth by housing status, 2011-14
(HICP-adjusted; percentages)
Source: Household Finance and Consumption Survey, waves 1 and 2.
Note: The chart shows the growth rates of the median net wealth in the euro area for outright owners, owners with a
mortgage and renters from 2011 to 2014, deflated by the HICP.
Assessing the overall implications of these many dimensions of heterogeneity is challenging. Recent ECB
research suggests that the most important dimension of heterogeneity is related to employment status.[12]
Following an easing of monetary policy conditions, there are disproportionate increases in income in the
lower part of the income distribution, which results in a decline in measured income inequality. By contrast,
since a majority of households are homeowners, an increase in house prices due to a looser monetary
policy has a relatively even impact of house prices across the wealth distribution.[13] At the same time, it is
worth keeping in mind that the degree of home ownership can vary considerably across countries. The
more concentrated ownership of equities and bonds among households means that this component of the
wealth distribution varies with the monetary stance, even while recalling that many households have
indirect financial holdings through pension funds and other types of investment vehicles.
From a broader perspective, we should also bear in mind that the contribution of monetary policy to
changes in inequality is small, compared with the role of fiscal policy (especially the degree of
redistribution in the design of the tax and transfer systems) and structural economic trends.
Differences across households also matter for the relation between aggregate income and aggregate
consumption. In particular, if an increase in aggregate income is not uniform across households, the
overall consumption response will depend on the marginal propensity to consume that is, the fraction of an
additional euro received that is spent on consumption - of the different household types. A rich empirical
literature has uncovered considerable heterogeneity in marginal propensity to consume across household
types. In particular, this literature finds that the spending decisions of households owning few liquid assets
are much more sensitive to shocks than the spending decisions of households that own sufficient liquid
buffers. Similarly, highly-indebted households tend to have a higher propensity to consume than savers.[14]
Quantifying the implications for the transmission of monetary policy of heterogeneity in the marginal
propensity to consume requires detailed institutional and socio-economic information on households at
higher frequency. This type of information is available in certain countries and it is encouraging that
researchers are starting to make use of it.[15]
The results indicate that this heterogeneity does play a role in shaping the transmission of monetary policy.
Beyond the intertemporal substitution channel, other channels have been highlighted by the expanding
literature on heterogeneous-agent New Keynesian (HANK) models.[16] These include: a "cash-flow"
channel, through which the decline in debt service for debtors means that they have more of their income
available for spending; an "income" channel, whereby higher consumption expenditure results from the
increase in employment and wages; and a "wealth" channel, such that the increase in asset valuations
generates more spending through wealth effects.
Some initial estimates of the quantitative impact of all these channels are also available for the euro area.
They are reported in Chart 8, where households are classified into three groups: (i) renters with limited
financial assets; (ii) homeowners with limited financial assets but possibly a (sizable) mortgage; and (iii)
homeowners with adequate financial assets. According to this classification, 10 percent of households in
the euro area are renters with limited financial assets, 12 percent are homeowners with limited financial
assets and 78 percent are homeowners with adequate financial assets.
Chart 8
Effects of a 100 basis point cut in interest rates on consumption in the euro area, depending on
household wealth
(change in consumption; percentages)
Source: Slacalek, Tristani and Violante (2019), Household Finance and Consumption Survey, wave 2.
This classification is relevant, since it has been argued that the two groups of households with limited
financial assets are more constrained in their ability to smooth consumption over time and tend to respond
more strongly to temporary changes in income.[17]
In addition, the composition of wealth of the different groups varies: while homeowners with limited
financial assets tend to have a mortgage (and their debt service decreases when the policy rate is cut), the
homeowners with substantial financial assets often experience lower returns on interest-rate-bearing
assets if the policy rate declines.
Chart 8 decomposes the overall effect on consumer spending into the components attributable to the
various transmission channels.[18]
First, the standard, intertemporal substitution channel is present only for financially-unconstrained
households which are able to save. It makes up only about a third of the total impact on aggregate
consumption. Second, the cash-flow channel is particularly strong for homeowners with limited financial
assets, who tend to have large mortgages, often with adjustable rates. Third, spending is substantially
stimulated via the income channel. This channel is heavily skewed towards lower-income households, who
also tend to benefit disproportionately from a stronger labour market. Fourth, the strongest asset price
effect occurs through the increases in house prices. This effect turns out to be quite large for highly
leveraged homeowners, since their consumption is more sensitive to house prices.[19]
Overall, the spending of the lower-income cohort and the cohort of homeowners with only limited financial
assets is much more strongly stimulated by monetary policy easing. A 100 basis point cut in interest rates
increases consumption of these groups by almost 1.0 percent and 1.6 percent respectively, while
consumption of the financially-unconstrained group increases only by 0.4 percent.
These estimates suggest that the standard intertemporal substitution channel substantially contributes to
the spending decision of many households, but the other three channels, which have traditionally been
neglected, are decisive for the consumption choice of the lower-income cohort and highly-leveraged
homeowners. These three channels contribute about two thirds of the total response of aggregate
consumption to a monetary policy shift. It follows that household heterogeneity can help to explain how the
effects of monetary policy can be relatively large, due to the larger consumption response of the
hand-tomouth group, even if the intertemporal substitution channel is weaker than in the representative agent
framework.[20]
To summarise, it is important to account for heterogeneity in the transmission of monetary policy, but this is
not a simple exercise. Comparisons between "winners and losers" based on a single channel, or a specific
factor, are necessarily incomplete and likely to prove misleading.
Concluding remarks
Let me conclude. Attention to variation across households and its relation to monetary policy is welcome. It
helps us to make progress in understanding the key features of the transmission mechanism of monetary
policy.
It is also very promising that the economics profession is finding ways to incorporate relevant dimensions
of household heterogeneity in our models. This flourishing field recognises that monetary transmission is
more complicated and dependent on many institutional features than suggested by the traditional
representative-agent model.
Further advances will require more data and more analysis. An essential source to estimate these effects
in the euro area is the HFCS. One avenue is to make use of the administrative data available in other
datasets (including tax data and credit registers) to complement and improve the information collected via
household surveys. I very much applaud this effort. Another important element is to better understand how
consumers form expectations.[21]
To this end the ECB is working on establishing a Consumer Expectations Survey, which we hope will
provide a useful basis to deepen our understanding of consumer behaviour at a granular level and the
extent to which this matters for macroeconomic outcomes.
[2]
For modelling approaches that just rely on aggregate data, see: Woodford, M. (2003), Interest and Prices: Foundations of a Theory of
Monetary Policy, Princeton University Press, Princeton; Smets, F. and Wouters, R. (2007), "Shocks and Frictions in US Business Cycles:
A Bayesian DSGE Approach", American Economic Review, Vol. 97(3), pp. 586-606; Del Negro, M. and Schorfheide, F. (2013), "DSGE
Model-Based Forecasting", in Elliott, G., Granger, C. and Timmermann, A. (eds.), Handbook of Economic Forecasting, Vol. 2, pp.
57140; and Christiano, L.. J., Motto, R. and Rostagno, M. (2014), "Risk Shocks," American Economic Review, Vol. 104(1), pp. 27-65. Some
limitations of macro-only analysis (such as excess sensitivity of consumption to interest rates) are highlighted by: Campbell, J. Y. and
Mankiw, N. G. (1989) "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," in Blanchard, O. J. and
Fischer, S. (eds.), NBER Macroeconomics Annual 1989, Vol. 4, National Bureau of Economic Research, pp. 185-246; and Canzoneri, M.
B., Cumby, R. E. and Diba, B. T. (2007), "Euler equations and money market interest rates: A challenge for monetary policy models,"
Journal of Monetary Economics, Vol. 54(7), pp. 1863-1881. For an aggregate perspective on household wealth and consumption, see de
Bondt, G., Gieseck, A. and Tujula, M. (forthcoming), "Household wealth and consumption in the euro area", Economic Bulletin, ECB.
[3]
The implications of the demographic structure of the population for the response of different age cohorts to a monetary policy shock
is considered in Leahy, J. V. and Thapar, A. (2019) "Demographic Effects on the Impact of Monetary Policy", NBER Working Paper
Series, No 26324, National Bureau of Economic Research.
[4]
See Nickel, C., Bobeica, E., Koester, G., Lis, E. and Porqueddu, M. (eds.) (2019), "Understanding low wage growth in the euro area
and European countries", Occasional Paper Series, No 232, ECB.
[5]
See Lenza, M. and Slacalek J. (2018), "How does monetary policy affect income and wealth inequality? Evidence from quantitative
easing in the euro area", Working Paper Series, No 2190, ECB.
[6]
See Dossche, M. and Hartwig, J. (2019), "Household income risk over the business cycle," Economic Bulletin, Issue 6, ECB.
[7]
Comparing the median of the total value of financial asset holdings to the median of the total value of real estate holdings, computed
across those households owning real estate.
[8]
Asymmetric effects of a monetary easing also discussed in Doepke, M., and Schneider, M. (2006), "Inflation and the Redistribution of
Nominal Wealth," Journal of Political Economy, Vol. 114, Nol 6, 1069-1097; Adam, K., and Zhu, J. (2016), "Price-Level Changes and the
Redistribution of Nominal Wealth across the Euro Area," Journal of the European Economic Association, Vol. 14, No 4, 871-906.
[9]
See Box 4.3 in Household Finance and Consumption Network (2016), "The Household Finance and Consumption Survey - results
from the second wave," Statistics Paper Series, No 18, ECB.
[10]
See Auclert, A. (2019), "Monetary Policy and the Redistribution Channel," American Economic Review, Vol. 109(6), pp. 2333-2367;
see also Tzamourani, P. (2019), The Interest Rate Exposure of Euro Area Households, Discussion Paper Series, No 01/2019, Deutsche
Bundesbank.
[11]
See Dossche, M., Hartwig, J., Pierluigi, B., and Velasco, A. (2019), "The redistribution of interest income in the euro area,
20082018," mimeo.
[12]
Lenza, M. and Slacalek, J. (2018), "How does monetary policy affect income and wealth inequality? Evidence from quantitative
easing in the euro area", Working Paper Series, No 2190, ECB.
[13]
Quantitatively, these results may differ across countries, depending on, for example, the reaction of employment and house prices
to monetary policy. At the same time, qualitatively these results also hold across large euro area countries, see Lenza and Slacalek op.
cit. for details.
[14]
See the reviews of the empirical literature by Jappelli, T. and Pistaferri, L. (2010), "The Consumption Response to Income
Changes," Annual Review of Economics, Vol. 2(1), pp. 479-506; Carroll, C. D., Slacalek, J., Tokuoka, K. and White, M. N. (2017), "The
Distribution of Wealth and the Marginal Propensity to Consume," Quantitative Economics, Vol. 8, pp. 977-1020, Table 1; and Crawley, E.
S., and Kuchler A. (2018), "Consumption Heterogeneity: Micro Drivers and Macro Implications," Working Paper, No 129, Danmarks
Nationalbank, Table 1. A related paper builds on heterogeneity in marginal propensities across savers and borrowers see Mian, A.,
Straub, L. and Sufi, A. (2019), "Indebted Demand," Harvard University, mimeo.
[15]
See Fagereng, A., Holm, M. B. and Natvik G. J. (2017): "MPC Heterogeneity and Household Balance Sheets," Discussion Paper,
Statistics Norway; and Crawley, E. S., and Kuchler, A., op. cit.
[16]
See Kaplan, G., Moll, B. and Violante, G. L. (2018) "Monetary Policy According to HANK", American Economic Review, Vol. 108(3),
pp.697-743. Of course, in addition to the New Keynesian framework, there is also a wider literature studying the implications of
household heterogeneity for macroeconomic dynamics through a variety of mechanisms. See, among others, Huggett, M. (1996)
"Wealth distribution in life-cycle economies", Journal of Monetary Economics, Vol. 38(3), pp. 469-94; Heathcote, J., Storesletten, K. and
Violante, G. L. (2009) "Quantitative Macroeconomics with Heterogeneous Households", Annual Review of Economics, Annual Reviews,
Vol. 1(2), pp. 319,354.
[17]
See, among others, Kaplan, G., Violante, G. L. and Weidner, J. (2014), "The Wealthy Hand-to-Mouth", Brookings, Papers on
Economic Activity, 45(1), 77-153, on the importance of accounting for hand-to-mouth households.
[18]
The figure is based on Slacalek, J, Tristani, O. and Violante, G. L. (2019), "Household Balance Sheet Channels of Monetary Policy:
A Back of the Envelope Calculation for the Euro Area", mimeo.
[19]
Slacalek et al. op. cit. also consider the effects on consumption via stock market wealth. In the euro area household portfolios are
heavily skewed toward housing, except at the very top tail of the distribution. Correspondingly, Slacalek et al. op. cit. show that the effect
of stock market wealth on consumption is limited, even for the non-hand-to-mouth households, also because their marginal propensities
to consume out of stock market wealth are very small. This result holds even after the holdings of stock market wealth by the
non-handto-mouth households in the survey are corrected for underreporting. Compared to aggregate sources, the survey covers about 70
percent of the stock market wealth at the euro area level.
[20]
Analogous additional amplification can occur via heterogeneity across firms due to differences in leverage and other factors; see,
amongst others, Jeenas, P. (2018), "Firm Balance Sheet Liquidity, Monetary Policy Shocks, and Investment Dynamics," Technical
Report.and Ottonello, P., and Winberry, T. (2018), "Financial Heterogeneity and the Investment Channel of Monetary Policy," Working
Paper, No. 24221, National Bureau of Economic Research.
[21]
For a discussion of household expectations of inflation, see Coeuré, B. (2019) "Inflation expectations and the conduct of monetary
policy", Speech at the SAFE Policy Center on 11 July 2019.
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