Luetticke, R

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Comment on "The Household Channel of Monetary Policy in theEuro Area: A Back of the Envelope Calculation" by Jiri Slacalek, OresteTristani and Giovanni L. Violanteby Ralph Luetticke1Before discussing the contributions of this paper, let me elaborate on thebroader context in which it is written. Over the past years, a growing numberof studies have revisited the transmission channels of monetary policy in modelswith heterogeneous households that face idiosyncratic income risk, borrowing con-straints, and portfolio choices. The introduction of borrowing constraints increasesthe relative importance of the budget constraint vis-a-vis inter-temporal substitu-tion in the monetary transmission mechanism. In this environment, monetarytransmission works to a larger extent through income and asset prices because themarginal propensity to consume out of transitory changes in cash-flows is higherthan in models with a representative household. The strength of these channelsdepends on the distribution of wealth and household portfolio balances, whichdetermines the fraction of constrained households.Slacalek, Tristani and Violante quantify these channels for the Euro area. Theydo so by aggregating individual household responses using theory and data. Thisrequires 3 steps: First, they theoretically derive the first-order change in householdconsumption to monetary shocks for three groups: poor hand-to-mouth, wealthyhand-to-mouth, and non hand-to-mouth households. Second, they estimate port-folio balances and the sensitivity of earnings to aggregate fluctuations for all threegroups from EU micro data (HFCS and EU-LFS). Third, they estimate the ag-gregate response of the interest rate, income, and asset prices to monetary shocksusing a SVAR approach with high-frequency monetary shocks as instruments. Fi-nally, they combine all three elements to provide an estimate of the consumptionresponse of each household group for Germany, Spain, France, and Italy.Let me briefly present their main findings before going into the details of theirprocedure. They find substantial heterogeneity in monetary transmission acrosshouseholds and countries in the Euro area. The key drivers are differences inportfolio balances. Consumption by wealthy hand-to-mouth households responds1University College Londonn, CEPR and CfM. November 2019.1the most to a monetary easing because they benefit from higher asset prices andlower debt burden. Transmission via asset prices and income is as important astransmission via interest rates in countries like Spain that have a large fractionof wealthy hand-to-mouth households. In Germany, by contrast, there are fewerwealthy hand-to-mouth households and transmission works to a larger extent viainterest rates. This sheds new light on monetary transmission in the Euro areaand provides guidance for future research.To arrive at these results, the authors make non-trivial approximations at eachstep of their procedure. In this discussion, I will focus on the first step: The theo-retical derivation of the first-order change in consumption. This derivation closelyfollows Auclert (2019). In particular, the derivation uses several simplifying as-sumptions. In the following, I will discuss three aspects of household portfoliobalances that are key for monetary transmission, and highlight a number of as-sumptions that are quantitatively important in my view.HousingIn the Euro area, wealthy hand-to-mouth households are typically homeownerswith a mortgage. The reported differences in the monetary transmission betweenthe three household groups (and hence between countries like Spain and Germany)crucially depend on the elasticity of consumption to house price changes. In theirderivation of this elasticity, the authors assume a linear housing transaction costand otherwise frictionless spot markets and divisibility of houses. As a conse-quence, all wealthy hand-to-mouth households consume a fraction of the gains inhouse prices within a year (the time period of analysis). This overestimates theconsumption response because only a small fraction of households sells their houseor re-mortgages to extract equity from the house. A quick fix would be to rescalethe house price channel by the fraction of houses sold or re-mortgaged. This woulddecrease the importance of the asset price channel and make monetary transmis-sion more similar across households and countries.Two more issues pertain to the treatment of renters and potential house buyers.The current treatment of housing does not consider that some households mightbe worse off when house prices increase. The authors focus on non-durable con-sumption and leave out expenditures on rents and on new housing. Households2about to buy a house are obviously worse off, while renters might benefit fromlower rents. Lower real rates most likely translate to a different degree into lowerrents vs. higher house prices across countries (achieving the same adjustment inthe rent-to-price ratio). This margin is a key determinant of the distributionalconsequences of monetary policy in the housing market; see e.g. Hintermaier andKoeniger (2018). These observations invite future research as differences in hous-ing markets explain most of the heterogeneity in monetary transmission across theEuro area.DebtPortfolio balances also markedly differ across households in terms of debt hold-ings. Following Auclert (2019), the authors estimate the importance of the Fisherchannel (real value of nominal debt) and unhegded interest rate exposure (realinterest on net issuance of debt) for monetary transmission. These two channelsare quantitatively most important for wealthy hand-to-mouth households, whobenefit from a reduction in the real value of their mortgage debt. While borrow-ers like wealthy hand-to-mouth households gain, savers lose. Crucially, savers innominal assets are mostly retired households. This age dimension of net nomi-nal positions in the Euro area has been highlighted before (see Adam and Zhu(2015), Tzamourani (2019)), but is neglected in this study. The derivation of theconsumption response assumes infinitely-lived households and constant labor sup-ply. Retired households differ in at least two dimensions that are important forthis study: 1) No labor supply (income depends on nominal pension benefits), 2)higher marginal propensity to consume toward the end of life. The first point im-plies that redistribution from retirees to workers has a negative effect on aggregatelabor supply, because wealth effects only matter for labor supply of workers; seee.g. Doepke et al. (2015). The second point also dampens the aggregate effectof monetary policy because it weakens the correlation between redistribution andpropensities to consume.PremiaFor the renumeration of portfolios after the monetary shock, the authors assumethat all maturing assets are remunerated at the risk-free rate. This overestimates3the effects of monetary policy. There is incomplete pass-through of the policyrate to many assets; see e.g. Gertler and Karadi (2015). This is the case formortgages which are the most important nominal assets for wealthy hand-to-mouthhouseholds. Other premia respond to monetary shocks as well. Using U.S. data,Luetticke (2018) documents incomplete pass-through of the policy rate to illiquidassets, like business capital or housing. Luetticke rationalizes this in a model withheterogeneity in household portfolios, in which capital including housing is illiquid.In this model, households do not only differ in marginal propensities to consumebut also in marginal propensities to invest in capital. Importantly, propensitiesto consume and invest are negatively correlated, such that redistribution acrosshouseholds mainly affects the composition of aggregate expenditures in terms ofconsumption and investment. This points toward the importance of studyingheterogeneity in investment decisions across households, which would complementthis paper’s focus on consumption.ReferencesAdam, K. and Zhu, J. (2015). Price-level changes and the redistribution of nominalwealth across the euro area. Journal of the European Economic Association,14(4):871–906.Auclert, A. (2019). Monetary policy and the redistribution channel. AmericanEconomic Review, 109(6):2333–67.Doepke, M., Schneider, M., and Selezneva, V. (2015). Distributional effects ofmonetary policy. Unpublished manuscript.Gertler, M. and Karadi, P. (2015). Monetary policy surprises, credit costs, andeconomic activity. American Economic Journal: Macroeconomics, 7(1):44–76.Hintermaier, T. and Koeniger, W. (2018). Differences in euro-area householdfinances and their relevance for monetary-policy transmission. CESifo WorkingPaper Series No 7088.4Luetticke, R. (2018). Transmission of monetary policy with heterogeneity in house-hold portfolios. CFM Discussion Paper Series, (CFM-DP2018-19).Tzamourani, P. (2019). The interest rate exposure of euro area households.Deutsche Bundesbank Discussion Paper.5

Comment on “The Household Channel of Monetary Policy in the Euro Area: A Back of the Envelope Calculation”

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