Finance and Accounting Research Seminar - Angus Foulis (Bank of England) "How Do Interest Rates Affect Consumption? The Household Debt Channel

Abstract: We combine the staggered expiry of mortgage deals in the United Kingdom, with administrative data on mortgages and consumption, to construct six million household-level natural experiments. We estimate the household debt channel—the causal effect of interest-rate changes on the cash-on-hand and consumption of indebted households. Our estimates are large: a 1 pp rate cut raises cash-on-hand by 1,800 pounds (1.4%), and consumption by 950 pounds (3%), implying a consumption response of 0.6% of GDP. Rate cuts matter due to a household financial accelerator—lower rates increase house prices and collateral values, leading to lower mortgage spreads, and higher cash-on-hand and consumption. Using plausibly exogenous variation in the sensitivity of house prices to interest rates, we show that the financial accelerator accounts for half of the effect of rate cuts.