Consumer Spending and the After-Tax Real Interest Rate

This paper examines the interaction between consumer durable goods and
consumer non-durable goods in determining the responsiveness of total
expenditure to the after-tax real interest rate. The introduction of
consumer durables into the consumer's decision problem can have important
effects on the interest elasticity of total spending. The channel
highlighted here might be called the "user cost effect," in that the
after-tax interest rate enters the implicit user cost of consumer durable
goods. Even if a consumer has a one-period planning horizon, possibly
because of a binding borrowing constraint, the user cost effect may
nonetheless make his spending highly interest sensitive. Finally, the
paper examines the response of the level and composition of consumer
spending to the high real interest rates experienced in the early 1980s.