Lumpy Durable Consumption Demand and the Limited Ammunition of Monetary Policy

Abstract: The prevailing neo-Wicksellian view holds that the central bank's objective is to track the natural rate of interest (r*), which itself is largely exogenous to monetary policy. We challenge this view using a fixed-cost model of durable consumption demand, in which expansionary monetary policy prompts households to accelerate purchases of durable goods. This yields an intertemporal trade-off in aggregate demand as encouraging households to increase durable holdings today leaves fewer households acquiring durables going forward. Interest rates must be kept low to support demand going forward, so accommodative monetary policy today reduces r* in the future. We show that this mechanism is quantitatively important in explaining the persistently low level of real interest rates and r* after the Great Recession.

Keywords: Monetary policy; Durable goods; Interest rates;

JEL Classification: E21; E43; E52;

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Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Staff Report

Publication Date: 2021-02-16

Number: 622