Monetary policy and household consumption spending in Portugal

This paper studies the effect of monetary policy across households of different Euro Area countries to understand the effects of the likely scenario of future interest rate hikes by the European Central Bank. Specifically, the paper studies mechanisms through which monetary policy may differentially affect households across the Euro Area.

The rise in interest rates should be especially relevant to those countries with high debt levels, like Greece, Portugal, Italy and Spain. By studying how monetary policy transmits to consumption, policymakers can better understand the different households’ financial vulnerabilities across member states and design policies that mitigate some of the adverse effects of contractionary policy on private consumption in the member states that are more exposed to interest rate shocks.

This paper studies the transmission of monetary policy to consumption in Portugal. It offers a back-of-the-envelope decomposition of the different monetary policy transmission channels based on the heterogeneous agent New Keynesian model. The paper finds that households with illiquid assets (mainly housing) but with no liquid assets have their consumption reacting the most to monetary shocks because of extensive housing wealth and net interest rate exposure channels. In addition, due to the large size of this group of households in the Portuguese economy, the paper finds that it explains why the aggregate consumption reacts more to monetary shocks in Portugal than in other European countries. In conclusion, the paper’s evidence suggests that the housing market’s institutional and financial setting in Portugal is a significant source of exposure to interest rate shocks in the Portuguese economy.

Click here to go to the paper by João B. Duarte and Nuno Pereira.