Study: Households cut spending on perceived inflation from rate hikes

The research, based on a large-scale survey of over 25,000 U.S. households, investigates how changes in the federal funds rate (FFR) influence consumer behavior.

Households report that an increase in the FFR leads them to reduce both regular and durable goods spending.

Crucially, this response is primarily driven by the belief that higher policy rates contribute to higher inflation, which in turn prompts them to cut consumption.

This mechanism, consistent with a 'cost channel' where borrowing costs rise, contrasts with standard New Keynesian models that emphasize real interest rate or income channels.

The study also notes a shift in portfolio allocations, with households moving away from stocks and towards bank accounts when anticipating higher policy rates, alongside a precautionary channel where policy actions signal increased uncertainty.

The findings diverge significantly from conventional New Keynesian frameworks, where policy rate increases typically reduce consumption via real interest rate or income channels.

The paper highlights that the income channel appears largely inactive, as households do not perceive a meaningful pass-through from policy rates to wages.

The study employs a two-step empirical approach: first, it identifies how households revise expectations in response to hypothetical FFR changes, and second, it estimates how these revisions translate into economic decisions using randomized information treatments.

Households expect higher policy rates to increase borrowing and saving rates, worsen economic conditions, lower stock prices, and surprisingly, raise housing prices, while wages remain largely unaffected.