This paper aims to estimate and quantify the percentage decline in consumption expenditure, which can be attributed to changes in house wealth, after monetary policy tightening. We use the structural vector autoregressive (SVAR) approach on South African disaggregated Absa house price data, namely all-size, large-size and medium-size and small-size house prices.
There are two channels through which interest rate changes can affect consumption, namely the direct and indirect effects (HM Treasury (2003). The direct link suggests that changes in interest rates affect consumption directly. The indirect effects operate in two stages. Firstly, changes in interest rates will impact on housing demand and supply which will consequently lead to changes in house prices and house wealth. Secondly, declines in housing wealth directly reduce current consumption. The direct effect suggests that increases in interest rates have an income or cash-flow effect. Any interest rate rises increase the burden of mortgage interest payments which directly reduce current consumption.
This implies that changes in interest rates can, to some extent, in the short term, reduce current consumption through altering the after-mortgage payments household disposable income available for current spending. HM treasury (2003) suggests that the direct effects of interest rates on consumer spending are stronger when individual households have net exposure on interest-bearing debt, a large proportion of contracts use variable interest rates, when consumers are credit constrained and when the link between base rate and mortgage rate is strong. Both ways of transmission of interest rates to consumer spending predict housing prices and consumption are inversely related to the prevailing level of interest rate.
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Monetary Policy Transmission, House Prices and Consumer Spending in South Africa: An SVAR Approach
