Abstract
This study assesses a new mechanism – the deposit channel – in the transmission of interest rate shock to household consumption using an administrative panel dataset of financial transactions for Turkey. Our empirical strategy exploits variation in consumer’s adherence to the Muslim laws that forbid earning interest and employs a standard difference-in-difference design. Following an unanticipated announcement of interest rate hike, rate-sensitive consumers significantly reduce their overall spending each month by 8.58 percent on average in the subsequent six months. The response persists throughout the post-announcement period and is much stronger among consumers with a higher level of liquid assets and who are relatively aged. The negative consumption response to the unanticipated policy shock is primarily concentrated in non-durable and discretionary spending. We show that the response of debt payment, disparate exposure to inflation, and exchange rate, the demographic difference can hardly fully account for the documented consumption response heterogeneity. Last, our estimate of the elasticity of intertemporal substitution indicates that the magnitude is economically small.
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