What Households Think Monetary Policy Does

Francesco Grigoli, Damiano Sandri, Yuriy Gorodnichenko, and Olivier Coibion

Standard New Keynesian models tell a clean story about how changes in interest rates affect households. Higher rates raise the real interest rate, leading households to postpone consumption, and slow economic activity enough to soften wage growth and employment, reinforcing the contraction through an income channel. In a recent paper, we use a survey of more than 25,000 U.S. households, combined with randomized information experiments, to ask how Americans believe monetary policy affects them. The answer differs from the textbook in one crucial respect: the dominant channel in households’ minds is neither the real interest rate nor income. Instead, it is inflation.

Households expect higher rates to bring higher prices

In Grigoli et al. (2026), we asked respondents to imagine that the Federal Reserve unexpectedly changed the federal funds rate by one, two, or five percentage points in either direction, and to report how they thought a range of economic variables would respond over the following year. Most answers line up reasonably well with what economists generally presume: households expect higher policy rates to push borrowing and saving rates up, unemployment up, and stock prices down, with little to no pass-through to wages.

The exception is consumer prices. Roughly two-thirds of respondents say that an increase in the federal funds rate would lead to higher inflation, not lower. When asked why, the most common explanations are that firms raise prices to cover higher borrowing costs, and that credit itself becomes more expensive — reflecting the cost-channel logic emphasized by Ravenna and Walsh (2006). Whether or not this view is empirically defensible, it is consistent with the well-known price puzzle in the data, especially over the first year following a rate hike. Households thus interpret tighter policy as inflationary over the horizons that matter for their decisions.

From beliefs to behavior

Knowing how monetary policy reshapes households’ expectations is only half the story. The other half is how those expectations translate into decisions. To estimate this, we use the survey’s eight randomized information treatments — small factual statements about wages, prices, interest rates, asset returns, and unemployment — as instruments for changes in expectations. Different treatments shift different beliefs, allowing us to identify the independent causal effect of each type of expectation on intended consumption while holding the others fixed.

The central result is that when households expect higher inflation, they plan to spend less, not more. This is at odds with the standard intertemporal substitution intuition, but consistent with earlier evidence in Coibion, Gorodnichenko and Weber (2022) and Georgarakos and co-authors (2024). The most plausible interpretation is precautionary: households respond to the prospect of higher living costs by trying to build up a buffer, or by reacting to the greater uncertainty that higher inflation typically brings. Higher expected income raises consumption strongly, but households see almost no link between the federal funds rate and their own wages, so the income channel is largely inactive.

Putting the pieces together

Combining the two steps allows us to decompose, channel by channel, why households think a one-percentage-point increase in the federal funds rate would change their spending. Figure 1 shows the result for total consumption over the next three months and over the following six to twelve months. Each colored bar represents the contribution of one channel — the change in expectations multiplied by the strength with which that expectation affects spending. The black dot indicates the net total.

Two features stand out. First, very little happens in the first three months: households perceive the immediate effect of a rate change on their spending as limited. Second, by the six-to-twelve-month horizon, the inflation channel (the grey block) dominates. It accounts for the majority of the projected decline in consumption, larger than borrowing rates, larger than saving rates, and many times larger than wages and unemployment combined. House prices provide a modest offset, since households expect housing to become more expensive after a rate hike. The pattern for durable goods is broadly similar, with the inflation channel again the main driver. In a standard New Keynesian model, the primary mechanisms operate through the real interest rate and income; in our households’ heads, neither matters much.

Other margins of adjustment

Households make many decisions beyond consumption. On the labor-market side, respondents say they would intensify their search for income — asking for raises, looking for better-paying jobs, working more hours — whether the Fed raises or cuts rates. Any change in the federal funds rate appears to be interpreted as a signal that uncertainty has gone up, prompting a precautionary response. Mortgage refinancing, paying down debt, and taking on new debt, by contrast, respond largely to rate cuts and show little to no response to rate hikes.

The same inflation-expectations channel that dominates the consumption response also drives household portfolio decisions. After the information treatments, we asked respondents how they would allocate a hypothetical $10,000 windfall across cash, bank deposits, stocks, bonds, gold, and cryptocurrencies, and we apply the same instrumental-variables approach. The dominant move following a perceived rate hike is a reallocation out of stocks and into bank deposits. Households expect the hike to depress stock returns and reallocate accordingly; they expect housing to become more expensive, leading them to build up cash reserves; and again, higher expected inflation reduces holdings of stocks and bonds while shifting modestly into gold and crypto, which households appear to treat as inflation hedges.

Implications for monetary policy communication

The channel through which monetary policy actually reaches American households is, to a first approximation, an inflation-expectations channel running in the opposite direction to that implied by standard models. Households see tighter policy as inflationary; higher expected inflation makes them want to spend less; and so tighter policy reduces consumption, but for a reason typically absent from most macroeconomic models. Two qualifications are worth noting. The survey speaks only to the partial-equilibrium response of households, not to the full general-equilibrium effects of monetary policy. And the strength of the household-level transmission depends heavily on financial literacy and basic awareness of what the Fed does; among households who lack both, the perceived effect of monetary policy on spending is essentially zero.

With those caveats in mind, the mechanism we identify is plausibly shaped by how monetary policy is communicated and reported. Press coverage of rate hikes typically leads with borrowing costs and the squeeze on consumers; the disinflationary intent of the policy is often left implicit. If households were instead persuaded that a rate hike is meant to lower inflation, and that it will, they might revise their inflation expectations downward rather than upward, and the dominant channel we measure would reverse sign. Whether central banks can deliberately move households away from the cost-channel interpretation is, in our view, one of the most important open questions in monetary policy today.

References

Coibion, Olivier, Yuriy Gorodnichenko, and Michael Weber, 2022. “Monetary Policy Communications and Their Effects on Household Inflation Expectations.” Journal of Political Economy 130 (6): 1537–1584.

Georgarakos, Dimitris, Olivier Coibion, Yuriy Gorodnichenko, and Geoff Kenny, 2024. “The Causal Effects of Inflation Uncertainty on Households’ Beliefs and Actions.” NBER Working Paper 33014.

Grigoli, Francesco, Damiano Sandri, Yuriy Gorodnichenko and Olivier Coibion, 2026. “Monetary Policy According to Households: Perceptions, Reactions and Channels.” Manuscript.

Ravenna, Federico, and Carl E. Walsh, 2006. “Optimal Monetary Policy with the Cost Channel.” Journal of Monetary Economics 53 (2): 199–216.