An age-structured model for the effect of interest rate changes on consumption

Abstract

A model for the effect of an interest rate change on household consumption is developed. The approach is age-structured: households reconsider their consumption patterns at the moment of the interest rate change and the changes of the consumption patterns are age dependent. These changes for different age groups contribute to the modification of aggregate consumption. Numerical simulation shows that a decrease of the interest rate leads to a consumption boost (a substantial increase of consumption in the short run), which diminishes as time passes and consumption gets fully adjusted to the new interest rate value. The consumption boost is achieved by an increase of the debt load.