Does household debt affect the transmission mechanism of monetary policy?

Abstract

We investigate the aggregate effects of household debt on a monetary policy easing shock using a smooth transition vector autoregression model. Using generalized impulse response functions, we measure whether the effect of a reduction in interest rate on output is conditioned by different levels of household debt in Australia, Sweden and Norway, three developed economies with high levels of household indebtedness, and in the world’s seven largest economies. Our findings show that the short-term effects of a reduction in interest rates are generally stronger during periods of high household debt. On average, the monetary stimulus (on impact) is 0.06% (percent of GDP) larger in Norway and the United States during periods of high household debt. Our findings also suggest high levels of household debt may diminish the persistence of monetary policy shocks in the medium term (4–8 quarters).