BPEA | 1972 No. 1

The Role of Interest Rates and Inflation in the Consumption Function

1972, No. 1

MOST OF THE ANALYSIS of the effects of interest rate changes on consumption has been concerned with (1) the relative importance of income and substitution effects in determining how households will allocate their resources over time, and (2) the substitution effect at a moment of time determining the demands for durable versus nondurable consumption goods. But two other types of interest rate effects on consumption—effects that have received little attention in the literature—may be of some importance and are the subject of this report. The rate of inflation enters the analysis because of the wedge it drives between the nominal and real rates of interest.