Will Monetary Policy Work? It Depends also on the Mortgage Market
TOMMASO MONACELLI AND TWO COAUTHORS SHOW THAT EUROPEAN CENTRAL BANK'S INTERVENTIONS ON INTEREST RATES RISK TO BE TRANSMITTED HETEROGENEOUSLY DUE TO THE DIFFERENT STRUCTURES OF THE NATIONAL MORTGAGE MARKETSWhen large rises in housing prices and property values are recorded, as happened in the decade preceding the burst of the housing bubble in several industrialized countries, this increased value can be used to finance new housing expenditure or for (non-housing) additional consumption. So, it is worth asking to what extent this value can serve as a collateral for credit availability to households and how much this mechanism affects monetary policy transmission.
These are the questions Tommaso Monacelli (Università Bocconi and Centro Baffi), Alessandro Calza and Livio Stracca(European Central Bank) address by analyzing the structure of mortgage markets, which varies significantly across countries. In their Housing Finance and Monetary Policy, (Journal of the European Economic Association, volume 11, Issue Supplement s1, pages 101-122, January 2013, doi: 10.1111/j.1542-4774.2012.01095.x), authors investigate the effects of monetary policy shocks on consumption, house prices, and residential investment in a sample of industrialized countries with respect to the flexibility of their mortgage markets.
The analysis shows that there is significant heterogeneity among the national mortgage markets across the main industrialized countries, and especially within the European Union – a feature scarcely highlighted in the recent debate about the crisis of the Euro. The main differences are the duration of mortgage contracts, the required levels of down-payments and the existence (or lack thereof) of equity release products.
The authors use these measures as indicators of the degree of development/flexibility of mortgage markets in the corresponding countries. Based on these measures, the study classifies the countries into two groups. The countries with more developed/flexible housing finance systems are the ones where the down-payment rates are low, mortgage equity release is common and the ratio of mortgage debt to GDP is high. The second group, in which the housing finance system is less developed/flexible, consists of countries with high down-payment rates, absent or partial mortgage equity release and low ratio of mortgage debt to GDP. Italy is clearly positioned in this second group.
The study also classifies countries according to the prevalence of fixed or variable interest rates as an additional measure.
When central banks cut interest rates, expectation is that the effects on consumption and investment are stronger in countries where the mortgage markets are more developed/flexible. When interest rates go down, consumption is stimulated more in countries where refinancing the mortgages is easier and in countries where borrowers can use their houses as ATMs (i.e. where the mortgage equity release is easier).
Authors show indeed that residential investment and house prices are usually more sensitive to interest rates changes in countries where the mortgage markets are more developed/flexible. Consumption, on the contrary, is significantly more responsive only in those countries where mortgage equity release is common and, especially, where the variable-rate prevails in mortgage contracts. However the authors show that other indicators of the flexibility/development of mortgage markets, such as the loan-to-value ratio and the ratio of mortgage debt to GDP, are not that relevant for explaining the differential response of consumption across EU countries to monetary innovations.
The results are especially relevant for the management of monetary policy in the Euro area, where centralized decisions taken by the European Central Bank risk to be transmitted heterogeneously across countries due to different structures of the mortgage markets.
by Morteza Zamanian
