Pedro Baptista Externals

1 Introduction Monetary policy affects consumption via multiple channels, with different effects on households’ decisions. By preserving price stability, monetary policy supports consumption in the medium run, as it protects the purchasing power of households. In the short run, however, tighter monetary policy typically dampens private consumption. First, higher interest rates reduce current consumption, as they increase the attractiveness of savings via the “intertemporal substitution channel”.

Despite recent ECB rate cuts, the average interest rate on mortgages is expected to increase further. This is because of lagged effects from the latest hiking cycle. The ECB blog shows that the resulting drag on consumption could last at least until 2030. Mortgage contracts often have interest rates fixed for long periods, or even for the entire duration of the contract. This implies that the average rate paid by households evolves only gradually with changing policy rates.