Traditional monetary policy’s effectiveness in controlling inflation through interest rate changes has weakened, as empirical data show easing no longer reliably drives consumer price inflation. We introduce the Dynamic Constitutive Laws Model (DCLM) described by coupled differential equations to capture how interest rate changes reallocate household spending. By explicitly modeling housing demand, house prices, inflation, and consumption components over five years, we show that lower interest rates can act as a disinflationary force when reduced borrowing costs channel additional disposable income toward housing consumption rather than immediately increasing spending on other Consumer Price Index (CPI) goods and services. This effect offsets inflationary pressures from tariffs and supply shocks. Calibrated on U.S. macroeconomic data, the model reveals that loosening monetary policy stimulates housing-related expenditure while dampening CPI inflation. Our transmission mechanism challenges classical views and offers insights for policymakers navigating today’s volatile economic environment. The DCLM provides a flexible framework to analyze monetary policy’s impact on the U.S. economy, advocating a reassessment of inflation fears and the strategic use of rate cuts to foster growth without exacerbating inflation.
Mark Cappelli (Tue,) studied this question.