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Lumpy Durable Consumption Demand and the Limited Ammunition of Monetary Policy

Staff Report 622 | Published February 16, 2021

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Authors

Alisdair McKay Senior Research Economist
Johannes F. Wieland University of California, San Diego and NBER
Lumpy Durable Consumption Demand and the Limited Ammunition of Monetary Policy

Abstract

The prevailing neo-Wicksellian view holds that the central bank's objective is to track the natural rate of interest (r*), which itself is largely exogenous to monetary policy. We challenge this view using a fixed-cost model of durable consumption demand, in which expansionary monetary policy prompts households to accelerate purchases of durable goods. This yields an intertemporal trade-off in aggregate demand as encouraging households to increase durable holdings today leaves fewer households acquiring durables going forward. Interest rates must be kept low to support demand going forward, so accommodative monetary policy today reduces _r\*_ in the future. We show that this mechanism is quantitatively important in explaining the persistently low level of real interest rates and _r\*_ after the Great Recession.