RDP 2016-12: The Household Cash Flow Channel of Monetary Policy 5. Quantifying the Aggregate Cash Flow Channel

Next, we combine the MPC estimates with the average net liquid wealth holdings of both borrowers and lenders to construct estimates of the cash flow channel for the overall economy. The necessary information is combined in Table 5.

Table 5: Aggregate Cash Flow Channel
  All households   HtM households
Borrowers Lenders Borrowers Lenders
Mean net interest-earning liquid assets ($)
Inline Equation
−194,600 39,600   −185,100 4,500
Interest rate change (bps)
−100 −100   −100 −100
Change in cash flows ($)
Inline Equation
1,946 −396   1,850 −45
MPCj 0.16 0.05   0.18 0.31
Change in durables spending ($)
Inline Equation
310 −20   338 −14
Growth in durables spending (%)
Inline Equation
3.2 −0.3   4.1 −0.4
Share of households (%)
50.0 50.0   12.2 7.0
Aggregate growth in spending per household (%) Inline Equation 0.2   0.1

Note: Estimates relate to the data underlying the regression analysis and hence to the sample period from 2006 to 2010

Sources: Authors' calculations; HILDA Survey Release 14.0

A 100 basis point reduction in interest rates would be associated with an average increase in interest-sensitive cash flows per annum of about $1,950 for borrowers and an average decrease of about $400 for lenders (i.e. the interest rate change multiplied by the mean net interest-earning liquid assets of each group). Given the MPCs of borrowers and lenders, this would correspond to an increase in durables spending of about $310 per annum for borrowers and a fall of around $20 per annum for lenders. (Alternatively, at the mean of durables spending for each group, this would be equivalent to a 3.2 per cent increase in durables expenditure for the average borrower and a decrease of about 0.3 per cent in durables spending for the average lender.)

Given that the household population is evenly split between net borrowers and lenders, this implies that, across all households, durables consumption per household would rise by about 1.5 per cent. The HILDA Survey indicates that durables expenditure makes up approximately 17 per cent of total (nominal) household expenditure. So, assuming no change in spending on non-durable goods or services, the results indicate that a 100 basis point cut in lending rates is consistent with an increase of about 0.25 per cent in aggregate nominal consumption per annum.

Applying the same rule-of-thumb calculations to the HtM household sample, lowering interest rates by 100 basis points would be associated with aggregate household spending rising by about 0.1 per cent per annum. The lower estimate is due to the fact that, while HtM households have relatively high propensities to consume, they account for less than 20 per cent of the household population and they hold lower levels of debt than non-HtM households, on average. However, in aggregate, the borrower cash flow channel is still a lot stronger than the lender channel. This is because the average HtM borrower holds over 20 times more net debt than the average HtM lender holds in net interest-earning liquid assets.

In summary, these back-of-the-envelope calculations suggest that the cash flow channel is a fairly important channel of monetary transmission. However, as this exercise demonstrates, there are a number of assumptions underpinning these calculations, so they should be treated with some caution.