November 5, 2021

How you experience a tightening in monetary policy—characterized by an increase in interest rates—may depend on your age.

A Federal Reserve Bank of Atlanta working paper published in August measures how exposure to monetary policy varies with the age of a household. It uses a model to establish that a surprise increase in the policy interest rate tends to boost the wealth and consumption expenditures of households that are in the early and middle stages of retirement while curbing the affluence and spending of younger working households and retirees over 80.

"There are winners and losers from a given change in monetary policy," said Anton Braun, a research economist and senior adviser in the Atlanta Fed's Research Department who cowrote the paper with Daisuke Ikeda, a senior economist at the Bank of Japan. "Monetary policy tightens, and some age groups are happy and others are less happy."

The Atlanta Fed's Toni Braun. Photo by David Fine

Braun and Ikeda analyzed Japanese survey data to measure income and wealth at various life phases and incorporated those results in a hypothetical study designed to ascertain what might happen at different ages in the event of a sudden spike in interest rates. The survey data suggest that people’s financial situation fluctuates according to age. Younger working-age households borrow to purchase homes and other durable goods and have relatively low net wealth. Households that are close to retirement, by contrast, tend to have high levels of wealth to rely on during their retirement. They also tend to have little or no debt and to hold a large fraction of their wealth in the form of bank deposits such as savings accounts. During retirement, households tend to run down their bank deposits first and to retain their home and other durable goods until late in life. Younger people also have lower labor income than do middle-aged workers, while public pensions are a major source of income for the oldest retired individuals.

These routine differences in income and the size and composition of wealth over the life cycle imply that changes in monetary policy might affect young, middle-age, and old households in different ways. The working paper’s authors use a life cycle model to measure the size of these differences, finding that they are large.

In their model, an unexpected increase in the monetary policy interest rate is "bad news" for a 31-year-old household but "good news" for a 71-year-old one. The younger household is likely to have recently purchased a home, a car, and other durable goods that it is financing with a mortgage or other debt, Braun explained. Because the jump in interest rates raises borrowing costs, a person in their 30s will likely face higher payments tied to the debt they carry. At the same time, the value of a 30-something’s house may not grow as quickly when rates go up because real estate markets typically underperform during periods of high interest rates.

"It makes sense for people in their 30s to borrow to acquire homes, cars, and other durable goods—because their labor earnings will likely rise in future years. That’s part of the life cycle," Braun said. "But a sudden [monetary] tightening could be unfortunate for them." Rising interest rates also tend to be associated with slower growth in jobs and wages, and younger workers have low wealth and rely heavily on labor income to finance their homes and other consumption expenditures.

The model used by the researchers suggests that people 57 to 80 years of age tend to fare better in the event of a surprise hike in interest rates. People in this age group benefit from a higher return on their large level of savings but also face the prospect of lower growth in the price of their home and other illiquid financial assets such as stocks. By suitably adjusting the rate at which they draw down liquid and illiquid assets, people in this age group can actually enjoy higher consumption now and in future years, Braun noted.

The working paper reflects an emerging focus on designing economic models that allow a better understanding of how monetary policy influences and is affected by the distribution of income and wealth. "Our results raise the possibility that monetary policy also has distinct effects on the situation of individuals who differ by gender, race, and education, and in future work, we plan to investigate this possibility," Braun said.

photo of Karen Jacobs
Karen Jacobs

Staff writer for Economy Matters