No abstract

Research interest in the reaction of consumption to expected inflation has increased in recent years due to efforts by central banks to kick-start demand by steering inflation expectations. We contribute to this literature by analysing whether various components of households’ balance sheets determine how consumption reacts to expected inflation. Two channels in particular are conceivable: an increase in inflation expectations can raise consumption through direct increases in expected real wealth, e.g. for households with nominal financial liabilities. By affecting the real interest rate, expected inflation can interact with wealth if only those households can adapt their consumption to current real interest rates that are not budget-constrained or sufficiently liquid to shift funds between consumption and savings. We investigate these channels empirically using household-level information on balance sheets, durable consumption and inflation expectations from the Dutch Central Bank’s Household Survey. We find that investments in risky assets as well as net worth moderates the relation between expected inflation and durable spending decisions. The net worth effect is most pronounced for households with fixed interest rate mortgages.

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