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How do interest
rates affect consumption in Ireland?

The research question I have chosen to write my dissertation
about is “How do interest rates affect consumption in Ireland”. The purpose of
this study is to see if monetary policy changes affect the Irish consumer and
what aspects of their life and consumption patterns are affected due to these
changes.

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I will investigate the Irish consumer in relation to several
different explanatory variables such as consumption, unemployment, savings,
inflation (CPI) and disposable income. This will provide me with an indication
of what are the biggest effects of monetary policy changes especially
concerning interest rate changes.

I will outline the main drivers of monetary policy change
and its effect in other countries as found in my literature review and compare
my findings back to studies carried out in different geographic and cultural
regions.

My research objectives include:

To investigate the effect of interest changes on
consumption in IrelandTo investigate the effect of interest changes on
unemployment in IrelandTo investigate the effect of interest changes on
household savings in IrelandTo investigate the effect of interest changes on
inflation in IrelandTo investigate the effect of interest changes on
disposable income in Ireland 

The financial
crisis of 2007 raised lots of questions about the efficiency of monetary policy
and how they manage to address shocks in economic cycles. Understanding
household patterns and responses to monetary policy changes has become
extremely important recently as it informs policy makers of which policy
options and implementations are likely to be most effective when making
monetary policy changes. This paper will examine the extent to which changes in
monetary policy affect households’ changes in consumption.

Historically, when
interest rates are low, this leads to increased consumption and when they are
high, this leads to a decrease in consumption. Although, is there a point when
interest rates get too low and are detrimental to society? Could they be the
cause of another financial crisis if they go and stay too low? On the other
hand when interest rates are extremely low, banks may not have enough
motivation for lending and may not participate in lending activities, thus
slowing down consumption.

I have chosen this
topic in light of interest rate changes over the previous three years which saw
Switzerland introduced negative interest rates back in 2015. This has been to
encourage large banks to lend or invest their excess reserves and to take the
interest burden off governments. It has also been to entice consumers to
consume more and spend more money. By implementing negative interest rates,
people make very little interest on their deposit accounts which discourages
savings and encourages spending, borrowing and investing.

Consumers have been
lucky since negative interest rates came in as they have not been passed on as
negative deposit rates on deposit accounts, if this was the case, people would
hold cash and this would greatly affect monetary policy, as when more and more
people hold cash, monetary policy becomes less and less significant. Banks are
striving to find ways to manage currency digitally so that they can overcome
this fear of people holding large amounts of cash. Consumers at the moment have
not been directly affected by changing interest rates but it is becoming
extremely more prevalent that these interest rates in fact seriously affect the
consumer and their lifestyle.

Literature Review

As part of my
research I have found similar and relative studies and papers conducted by
people in different parts of the world for which I can compare my answers to
and base some of my research objectives on. My sources for my literature review
are secondary sources like most of my data except news articles and journals
which I may use in my introduction and to quote important information I feel is
relevant.

Lacy (2012)
conducted a study called “How are interest rates affecting household
consumption and savings?” Lacy (2012) paper explores what is the optimal
interest rate that maximises household savings and consumption and whether
artificially low interest rates are affecting consumption positively or
negatively. At the time of writing the paper Lacy (2012) mentioned that there
was speculation to whether the US needed to raise their interest rate in order
to provide financial institutions and banks incentives to lend money, thus
increasing household consumption. At the time of the study, federal interest rates
were between 0 and 0.25. The aim of this study is to find a stable interest
rate that increases consumption while maintaining a modest savings rate.

Vengelen (2015) also studies how long
term interest rates affect consumption. The title of this work is “Household
Consumption and Long-Term Interest Rates”. 
Venegelen (2015) also focuses on the aftermath of the financial crisis
and tries to figure out if monetary policy and fiscal policy are being
conducted correctly. The author uses a consumer expenditure survey and a base
mortgage Interest rate survey in order to conduct the study.
Vengelen (2015) speaks about the argument that the financial crisis was mainly
driven by economic policy as consumers’ debt levels became higher and higher
and eventually led to the downturn of the economy.

W.
Elmendorf (1996) used a survey to find “The Effect of Interest Rate Changes on
Household Savings and Consumption”. This study was conducted in 1996 so some of
the findings in the study could be slightly outdated, but for comparison, this
is a good paper. The main objective of this study is to find the interest
elasticity of saving and what other factors could affect this figure. The
interest elasticity of saving means the change in saving (%) resulting from a
one percent change in the interest rate.

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