Monetary policy transmission and household debt dynamics: Evidence from wavelet quantile regression (WQR) and wavelet quantile correlation (WQC) analysis

Abstract

Central banks must closely monitor household debt because it shapes aggregate spending behaviour and influences how households respond to economic shocks. The macroeconomic effects of such shocks depend not only on the overall level of household indebtedness, but also on the interest-rate sensitivity and maturity structure of household liabilities. High debt exposure can amplify changes in consumption, especially when borrowing costs rise or income conditions weaken. Against this background, this study examines the effect of monetary policy on household debt in the United States using quarterly data from 2005Q1 to 2025Q1. Furthermore, given the nonlinear nature of the variables, we use nonlinear approaches, including wavelet quantile regression (WQR) and wavelet quantile correlation (WQC). The ADF and PP results validate each other, showing evidence of stationarity. The findings reveal that policy interest rate hikes have weak short-run effects but strong, medium- and long-term debt-constraining impacts on highly leveraged households. Conversely, increases in the money supply lead to widespread increases in household debt, particularly for the most highly leveraged households, aligning with liquidity-driven credit cycles. Exchange rate depreciation has no immediate effect on household debt but is positively associated with long-term debt accumulation among highly leveraged households, primarily due to imported inflation and liquidity substitution. Consumption expenditure shows a strong positive co-movement with household debt across most debt quantiles and time horizons, whereas capital formation is linked to increased debt only in the long run. Wavelet quantile coherency estimates confirm these trends, highlighting larger and more persistent co-movements between monetary variables and household debt in the medium-to long-term frequencies. Based on the study's findings, recommendations for practical policy decision-making are derived from the broad research results to guide relevant stakeholders and decision-makers in pursuing more effective monetary policy for managing household debts.