Monetary policy shocks from the consumer perspective

by Edda Claus, Viet Hoang Nguyenb

Group Members:​ Chitwan Garg | Varanasi Nitesh | Shreyansh Rai |

Prashant Kardam | Sahil Bansal

Introduction:
This paper attempts to examine the effects of monetary policy shocks on various
consumer expectations. This paper distinguishes between policy tightenings and
easings and examines their effect on both immediate and longer run responses in
consumer expectations. To study the immediate responses to monetary policy
shocks, a latent factor model is applied which relies on monetary policy
announcements from the Reserve Bank of Australia (RBA) to identify monetary
policy shocks. They computed the cumulative dynamic effects from an estimated
NARDL model to study the longer-run adjustments of expectations. The data used
for the study are from the ‘Consumer Attitudes, Sentiments and Expectations’
(CASiE) survey.
Data Collection and Index Computation :
1. CASiE Survey:
Households are surveyed in relation to:
(i) current family finances (family finances now compared to 12 months ago)
(FamFin); future family finances (family finances in the next 12 months compared to
now) (FamFin1y); short-term economic conditions (next 12 months) (Eco1y);
medium-term economic conditions (next 5 years) (Eco5y); consumer readiness to
spend (a good time for people to buy major household items) (Spend);
unemployment expectations (Uemp1y)(unemployment level in next 12 months);
Inflation expectations (Inf1y) (price level in the next 12 months)
FamFin and FamFin1y provide information about the income effect of monetary
policy changes. Eco1y and Eco5y give information on the effects of monetary policy
actions. Spend, or ‘a good time to buy major household items’, represents the
interest rate channel.
The responses to each of the qualitative survey questions (Q1 (FamFin), Q2
(FamFin1y), Q3 (Eco1y), Q4 (Eco5y), Q5 (Spend) and CUE (Uemp1y)) are
cumulated into an index as follows:

o​i,j​ and p​i,j​ represent the optimistic and pessimistic responses respectively.
2. Monetary policy dates :
Policy change dates are based on RBA press releases. 2 types of monetary policy
days are encountered, one with a rise in the TCR and the other with a fall in TCR .

In the above table we compute the ratio between standard deviations of index on
monetary policy months compared to months without policy changes, which if
greater than 1 means that responses vary more in policy months compared to
non-policy months.
Immediate Responses(Short Run):
a​t represents
​ economic news that impact consumer expectations.In some months,
there will be changes in monetary policy with an element of surprise. We observe 2
types of surprises viz. tightening and easings. m​t​ represents surprise tightenings and
n​t ​represents surprise easings.
This framework can be translated into a latent factor model where consumer
responses are a function of one or more latent factors as follows

where ind​i,t​ is the index related to each of the five questions and unemployment
expectations, i = FamFin, . . .,Uemp1y, at time t. d​i,t​ represents the idiosyncratic
shocks to ind​i,t​ and is like an error term. δ​i​, λ​i​, α​i​ and β​i​ are the factor loadings.
Longer Run Responses:
NARDL (nonlinear autoregressive distributed lag) is used to study the longer run
responses. We can assess how consumer expectations adjust in the longer run by
estimating the cumulative dynamic multiplier effects from the model.
The NARDL(p, q) model is expressed as

where P​t​ denotes one of the indexes: FamFin1y, Eco1y, Uemp1y, and Inf1y; μ​i​ is the
t t
autoregressive parameter;Q​t​+​ = Σi=0 Δ Q​i​+​ and Q​t​-​ = Σi=0 Δ Q​i​-​ are cumulative sums
of increases and decreases in the TCR.
Q​t​+​ = max( ​Δ​Qt, 0) and Q​t​-​ = min (​Δ​Qt, 0) denote rate rises and rate cuts, ​Δ​Q​t
denotes the change in the TCR at time t. The asymmetric effects of increases and
decreases in the TCR on expectations are captured in X​i​+​ and X​i​-​.
Results:
Immediate Response:
1. With an assumption that most households are net borrowers, a policy tightening
shock should result in downward pressure on expected future financial conditions,
expected future economic activity and on readiness to spend, but should result in
upward pressure on unemployment expectations.
2. Given that n​t​ are mostly negative shocks, the factor loadings on n​t​, β​FamFin​ to β​Spend​,
are also expected to be negative and βUemp1y to be positive so that an easing
shock puts upward pressure on expected future financial conditions, economic
activity, and buying intentions but downward pressure on unemployment
expectations.
3. Aggregate estimation results suggest that policy tightenings put downward
pressure on the readiness to spend (α​Spend​ < 0) and easings put an upward
pressure on the readiness to spend (β​Spend​ < 0) which is consistent with the
interest rate channel of monetary policy.
Longer run:
The above figure, plots the cumulative dynamic multiplier effects at the aggregate
level over a 24-month horizon. The results are interpreted as the effects of a unit
increase/decrease in the TCR on expectations.
1. A positive (negative) value of the multiplier effect means that policy shocks put
upward (downward) pressure on expectations.
2. The above figure reveals that there are large adjustments in consumer
expectations around 9 to 12 months after shocks.
Conclusions:
● Consumers adjust expectations on economic activity, unemployment, family
finances and readiness to spend immediately following a monetary policy
shock. Inflation expectations are initially anchored and only respond in the
longer run.
● It seems likely that the immediate change in current family finances has an
immediate impact on household consumption decisions. This means,
monetary policy may affect real activity with a much shorter lag than currently
recognized.