In the literature the discontinuity of the marginal revenue and therefore the rigidity of prices is found as a consequence of some kind of oligopolistic competition among firms Sweezy and Hall; Hitch In our case, the kinked demand results from the endeavor of borrowers to maintain the status quo in their consumptions.
Proposition 1. The proposition above implies the shape shown in Figure 2 for the loan demand. In each kink it is easy to verify the asymmetric response of demands for loans with respect to interest rate changes. Proposition 2. Proposition 2 asserts that any change in the marginal cost that leaves it in the interval I 2 will not have effect on the equilibrium interest rate which will remain in r 2 and as a consequence, the loan demand will remain equal to m 2 , this is the rigidity of the interest rate.
Figure 3 shows the shape of the marginal revenue and one possible position of the marginal cost where we obtain the rigidity. If in addition, the monopolistic bank finances the Government debt too; we can obtain an important conclusion from the rigidity of the market interest rate with respect to changes in the interest rate paid by the Government.
If M is the total amount of resources available to the bank to lend either to the borrowers or to the Government, the problem of the lender results:.
In order to illustrate the main result of the paper, we provide the following example. It will also allow us to show how sequential marginal cost reductions may provoke a sudden increase in the loans amount.
The demand for loans is given by:. This is the rigidity of the interest rate. In addition, we would like to comment on another remarkable effect of the model. If the marginal cost belongs to the interval I 1 , the profit of the monopolist will exhibit two relative maximums. Figure 4 depicts the profits for three values of the marginal cost. As we can observe, reductions in the marginal cost provoke a jump discontinuity in the total amount of credit supply.
Figure 5 shows the discontinuity of the equilibrium loan amount m c with respect to the marginal cost of the monopolist c. The explanation for this effect is the following. This is done by augmenting both consumptions, taking more credit in the first period and delivering a lower part of the debt.
This is an important effect that monetary authorities must take into account in the process of reducing the basic interest rate of the economy.
There is a threshold value for this interest rate from which agents significantly increase the credit demand, the current and the future consumption and the default. If the objective is to reduce the interest rate without provoking inflation due to the increase in consumption or increasing the default on debts, the authority has to consider this perverse effect.
In this paper we provided an explanation of the asymmetry of the loan demand response to changes in the interest rate. The kinked demand for loans that provokes that effect is a result of the borrowers' willingness to maintain the status quo in their former consumptions.
As a consequence, the marginal revenue of the monopolistic bank presents a discontinuity, generating rigidity of both the interest rate and loans with respect to changes in its marginal cost. This kind of consumption habit was not used to explain phenomena of asymmetry and rigidity in the literature, so it provides another explanation that may complement the theories of sticky prices based on concentration or collusion of firms in specific markets.
Using the same model, we show that the amount of loans may have a sudden increase when the marginal cost of the monopolist is reduced. The low penalty for defaulting on a small debt due to the small market interest rate allows increasing consumption in both periods taking out more loans in the first period and delivering a lower part of the debt in the second period. From the monetary policy point of view, both effects described in the paper the rigidity of the interest rate and the discontinuity in the amount of credit are market imperfections that policy-makers must take into consideration.
This is because, as we noted in the comments of section III, it is possible that the monetary policy instrument the interest rate paid by the Government on its loans , might not be effective if it falls into the region of interest rate rigidity or even provoke a sudden increase in inflation and increase in the default on debts.
Proof of Proposition 1. The borrower problem is to maximize 1 restricted to the budget set:. We are imposing bounded short-sales in order to guarantee finite solutions. Case I. Whenever necessary, we will denote the demand for loans in this case by m I r. In order to compatibilize with , we must have:. Case II. In this case, the loan demand is denoted by m II r. As in case I, the restriction implies the following demand for the interest rate:.
Case III. The first order condition is:. As done formerly, we denote the demand for loans here by m III r. Furthermore, the following limit exists,. To prove the non-differentiability of m r in r 1 , we use equations A1 , A3 and A5 to calculate the derivatives in each interval, namely:. Therefore, we can conclude that,. Proof of Proposition 2. In m 1 the behavior is qualitatively different.
If we calculate the marginal revenue in that point we will have. Abrir menu Brasil. Abrir menu. Maldonado Augusto M. Oliveira About the authors. Consumption habits and interest rate rigidity Wilfredo L. Introduction One of the main concerns in applied and theoretical economics is the absence or slow response of some economic variables to shocks in fundamentals or in economic policy instruments. Athey, S. Review of Economic Studies, v. Calvo, G. Journal of Monetary Economics, v. Campbell, J.
Princeton University Press, Princeton. Carlton, D. The American Economic Review, v. Handbook of Industrial Organization R. Schmalensee and R. Willig Eds. Carroll, C. Dubey, P. Econometrica , v.
Dynan, K. Fuhrer, J. The American Economic Review , v. Hall, R. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money.
Personal Finance. Your Practice. Popular Courses. Monetary Policy Interest Rates. Table of Contents Expand. Interest Rate Changes. Spend or Save? The Bottom Line. Key Takeaways Central banks adjust target interest rates in a country, raising them to increase the cost of borrowing when the economy is hot, and lowering them to make borrowing cheaper when the economy is sluggish.
When interest rates go up, consumers may be more attracted to saving dollars that can earn higher interest rates rather than spend. When rates go down, people may no longer wish to save, but instead spend and invest, even taking out loans to consume at low interest rates. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.
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Related Terms How Multipliers Impact Economics A multiplier refers to an economic input that amplifies the effect of some other variable. What Is a Macro Environment? Marginal Propensity To Consume MPC Marginal propensity to consume represents the proportion of a pay raise that is spent on the consumption of goods and services, as opposed to being saved. Consumer Discretionary Consumer discretionary is an economic sector comprising non-essential products that individuals may only purchase when they have excess cash.
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