## CHAPTER 2 FEELING THE PINCH? TRACING THE EFFECTS OF MONETARY POLICY THROUGH HOUSING MARKETS ## Source details **Canonical URL:** [CHAPTER 2 FEELING THE PINCH? TRACING THE EFFECTS OF MONETARY POLICY THROUGH HOUSING MARKETS](https://www.imf.org/-/media/files/publications/weo/2024/april/english/ch2.pdf) ## Other formats - [Markdown version](/-/media/files/publications/weo/2024/april/english/ch2.pdf.md) - [Structured JSON version](/-/media/files/publications/weo/2024/april/english/ch2.pdf.json) --- ### Overview and context - Since late 2021, central banks around the world have raised policy interest rates at a speed, degree, and breadth unprecedented in at least 40 years to restore price stability. - Reopening-related supply-chain disruptions and the war in Ukraine hit post-lockdown economies with a series of supply shocks; these shocks, combined with extraordinarily supportive fiscal and monetary policies during the pandemic, supercharged inflation to levels not seen in decades. - Despite the sudden rise in interest rates, global growth proved surprisingly resilient in 2023; economic activity outpaced expectations in most countries, and employment remained robust while inflation retreated significantly. - Postpandemic tightening followed an extended period of low interest rates; at the start of the recent hiking cycle, effective mortgage rates had reached their lowest point in decades in many countries (examples: France 1.5 percent, Germany 1.7 percent, United States 3.3 percent, after declining from 4.0, 4.5, and 4.5 percent in 2011, respectively). - Low rates and pandemic-era structural changes led to rapid house price growth; residential real estate prices are still well above prepandemic levels but stabilized and even declined in some economies in 2023. ### Research questions addressed - Where are real estate and mortgage markets now? How have they evolved following the global financial crisis, the pandemic, and the recent monetary tightening? - Conceptually, what are the housing channels of monetary policy transmission? How are housing channels tied to mortgage and housing market characteristics? - How do the housing channels vary across countries? - Have the housing channels weakened in recent years? ### Methods and data (high-level) - Conceptual framework linking housing channels of monetary policy to mortgage and housing market characteristics. - Empirical methods follow Jordà (2005), Stock and Watson (2018), and Chen and others (2023). - New data used: - Monetary policy surprises against analyst predictions, to identify exogenous changes in interest rates. - Prevalence of fixed-rate mortgages across countries, from public sources and national authorities. - A new regional data set of house prices and real activity. - Model simulations assess joint effects of the prevalence of fixed-rate mortgages and regulatory loan-to-value (LTV) limits. - Empirical strategy: local projections instrumental variable framework mapping mortgage and housing market characteristics to monetary transmission using newly constructed monetary policy shocks based on deviations of actual rate decisions from analysts’ expectations. - Data and sample: country-level panel of 33 emerging market and advanced economies; regional data set (reduced number of countries) for housing market characteristics. Sample coverage for some cross-country distributions: 1998:Q4 to 2023:Q1. ### Conceptual summary — Seven housing channels of monetary transmission - The chapter summarizes seven stylized channels (Figure 2.5) through which policy rates transmit via housing to household consumption and residential investment: 1. Cash flow channel: rising policy rates directly depress consumption of homeowners with adjustable-rate mortgages who cannot borrow easily. 2. Expectations/risk premium channel: changes in interest rates and expectations about future house prices affect demand for housing and mortgage pricing. 3. Wealth channel: falling house prices lower homeowners’ wealth and thus consumption. 4. Collateral channel: lower home values reduce collateral, restricting access to credit and lowering consumption. 5. Interest rate channel: higher policy rates lead to higher mortgage rates, reducing demand for credit and housing. 6. Bank lending channel: higher funding costs or lower deposits reduce bank lending. 7. Balance sheet channel: lenders reduce credit to riskier households anticipating lower borrower net worth and higher default risk. - Additional mechanisms noted: a risk-taking channel and effects of unconventional monetary policy (for example, quantitative easing) via portfolio-rebalancing and expectations/risk premium channels. - The figure abstracts from second-round effects from consumption and investment back to house prices and credit and ignores effects on rents and unconventional monetary policy for clarity. ### How mortgage market characteristics modulate transmission - Three country-level mortgage market characteristics studied: 1. Share of fixed-rate mortgages (FRMs) in the stock of outstanding mortgages (FRMs defined as nominal payments that do not reset within a year). 2. Regulatory loan-to-value (LTV) limits on mortgages. 3. Ratio of household debt to GDP. - Key heterogeneity facts: - FRMs are rare or nonexistent in some countries (for example, Finland and South Africa) and are the majority in others (Belgium, Mexico, and the United States). - Regulatory LTV limits can be as restrictive as 45 percent in Korea and as high as 100 percent or more in France, Germany, and the United States. - Household debt is below 50 percent of GDP in some countries (for example, Chile, Colombia, and Israel) and exceeds 100 percent of GDP in others (Australia, Canada, and Norway). ### Empirical findings on mortgage market characteristics - Fixed-rate mortgages (FRMs): - No significant differences found in the transmission of monetary policy to house prices between high-FRM and low-FRM countries. - A high share of FRMs significantly dampens the transmission of monetary policy to consumption relative to when FRMs are rare, with differences becoming significant after five quarters. - Interpretation: the cash flow channel is muted when mortgage payments do not adjust quickly due to FRMs, delaying interest-rate pass-through to household consumption. - LTV limits: - Differential effects assessed by comparing “LTV restricted” (LTV limits below 100 percent) to “LTV not restricted” groups. - Household debt: - Differential effects assessed by comparing “High household debt” (household debt to GDP above the sample median) to “Low household debt” groups. - Methodological note: lines in differential-effect figures reflect cumulative percentage point responses to a 100 basis point change in policy rates; horizontal axes represent quarters (0–8); shaded areas represent 90 percent confidence intervals; diamonds indicate statistical significance at least at the 10 percent level. ### Timing, asymmetry, and pathway details - Fixed-Rate Mortgages and timing: - Many consumers do not feel the pinch of rising policy rates until the rate on their mortgage resets, temporarily reducing the strength of the cash flow channel. - FRMs matter more when monetary policy is tightening: borrowers with FRMs have less incentive to refinance when rates rise, so FRMs limit transmission more in tightening cycles. - When policy rates are lowered, borrowers with FRMs who can refinance may reduce monthly payments, lessening FRMs’ dampening effect on transmission. - LTV limits and household indebtedness: - Tighter regulatory LTV limits delay monetary policy transmission and amplify differences in responses. - Example: eight quarters after a 100 basis point increase (decline) in policy rates, house prices drop (rise) by 1 percentage point when LTV limits are restricted and by 4 percentage points when LTV limits are not restricted. - By the fourth quarter the effect when LTVs are restricted is about half of what it is when they are not. - Household indebtedness strengthens and accelerates transmission. - Example: eight quarters after a change in monetary policy, nominal house prices respond about 3 percentage points more when household debt ratios are above the sample median relative to when they are below. - The consumption response to a monetary policy impulse is significantly faster if debt is higher, with statistical differences winding down after three quarters. - Asymmetry: supply constraints and price overvaluation matter more when monetary policy tightens; symmetry can be rejected only for house prices and in the first two quarters in the tested specification. ### Model simulations — complementarity of FRMs and LTV limits - Two-agent New Keynesian model with housing and leverage (Chen and others 2023) illustrates joint effects. - Complementarity quantified in model simulations (responses to a 100 basis point change in policy rates): - Moving from high to low FRMs given loose LTV limits: transmission rises by 17 percent (red to yellow line). - Moving from high to low FRMs given tight LTV limits: transmission rises by 13 percent (blue to green line). - Moving from loose to tight LTV limits given low FRMs: transmission rises by 23 percent (green to yellow line). - Moving from loose to tight LTV limits given high FRMs: transmission rises by 19 percent (blue to red line). - Parameter definitions used in figure: Tight and loose LTV stand for LTV of 0.75 and 0.9, respectively. High and low FRM stand for a share of fixed-rate mortgages of 0.95 and 0.7, respectively. - Conclusion from simulations: transmission to household consumption is weakest under more restrictive LTV limits and highly prevalent FRMs. ### Local housing market characteristics: supply constraints and overvaluation - Supply constraints (proxied by population density) strengthen transmission: - Following a 100 basis point tightening (loosening), nominal house prices decline (rise) by an additional 3 percentage points after eight quarters in areas with restricted housing supply compared with less-restricted areas. - Real GDP per capita undergoes an additional decline (rise) of 2 percentage points at peak in supply-restricted regions. - The house-price effect is 50 percent larger than the average effect of monetary policy on house prices; the GDP per capita effect is about one-third larger than corresponding average effects. - Effects in supply-restricted regions are more back-loaded. - Recent house price overvaluation strengthens transmission: - Following a 100 basis point tightening (loosening), the peak fall (rise) in nominal house prices is 1.5 percentage points greater in areas with recent house price overvaluation relative to those without. - Real GDP per capita declines (rises) an extra 1 percentage point in regions with recent overvaluation (about two-thirds of the average effect). - The differential effect is back-loaded for GDP per capita; house price differentials peak at about five quarters. - Mechanisms: expectations, collateral, and wealth channels are important; overvaluation is often accompanied by excessive leverage and spirals of falling prices and foreclosures when policy tightens. ### Cross-country and regional variation - Heat map (based on 2022 data or latest available) shows substantial cross-country variation in transmission strength across five axes: share of fixed-rate mortgages, regulatory LTV limits, household debt, housing supply restrictions, and house price overvaluations. - Darker reds indicate stronger housing-channel transmission relative to cross-country distribution; lighter reds indicate weaker transmission. - Examples: - Australia and Japan appear to have stronger housing channels: low shares of fixed-rate mortgages, less-restrictive LTV limits, high household debt (Japan only to some extent), and an elevated proportion of population in supply-restricted areas. - Colombia, Hungary, and Israel are more likely to exhibit weaker transmission, with notably low levels of household debt and supply constraints. - Caveats: columns in the heat map cannot be compared or aggregated for each country; the figure focuses only on housing channels and not on other channels (for example, exchange rate channel for emerging and highly open economies). - Evolution since the global financial crisis and pandemic: - Fixed-rate mortgages have become more prevalent, with the increase driven by low rates. - Regulatory LTV limits have either tightened or remained stable. - Household debt ratios increased in some countries (notably Chile, France, and Korea) and decreased in others (for example, Denmark, Ireland, and Spain). - National-level housing supply is likely more elastic in most countries due to migration from densely populated urban areas to less dense rural or suburban areas during the pandemic. - House price overvaluation changes were mixed: some overvalued areas saw stagnant or declining price-to-income ratios (for example, Finland and Hungary), while in other countries overvaluation rose where prices were already overvalued (for example, Mexico and The Netherlands). ### Key statistics and precise observations - Empirical sample size: 33 emerging market and advanced economies. - House prices and residential investment together represent about 70 percent of GDP in most economies. - Since the beginning of the current hiking cycle, nominal house prices declined in about a third of countries in the sample. - House prices remained elevated at the end of 2023 in most countries. - Distribution/timing notes: - Distribution of country-level changes measured between the quarter of the first country-level rate hike and 2023:Q2. - Cross-country distribution sample covers 1998:Q4 to 2023:Q1. - Examples of mortgage market extremes: - Korea: LTV limits as restrictive as 45 percent. - France, Germany, United States: LTV limits as high as 100 percent or more. - Household debt: below 50 percent of GDP in Chile, Colombia, Israel; exceeds 100 percent of GDP in Australia, Canada, Norway. ### Policy-relevant implications and recommendations - Macroprudential context: - Tighter borrower-based macroprudential regulation improves financial and economic stability; monetary policy may have smaller effects in countries with relatively tight regulation because borrowers are on average less leveraged and less sensitive to changing interest rates. - This cushioning effect is desirable insofar as it allows monetary policy to focus on managing aggregate demand and price pressures without precipitating a financial crunch. - Monetary policy implications: - A deep, country-specific understanding of housing channels is important for calibrating and adjusting monetary policy. - In countries where housing channels are strong, monitoring housing market developments and changes in household debt service can help identify early signs of overtightening. - Where transmission is weak, more forceful early action can be taken when signs of overheating and inflationary pressures first emerge. - Prudential recommendations and risks: - High prevalence of FRMs can delay and dampen the impact of monetary policy on household consumption (cash flow channel), reducing immediate effectiveness of rate hikes in curbing consumption. - Despite wider adoption of fixed-rate mortgages, fixation periods are often short; as rates on these mortgages reset over time, monetary policy transmission could suddenly become more effective and depress consumption. - Financial instability could follow if defaults rise abruptly, especially where households are highly indebted or bankruptcy laws favor borrowers. - Overvalued markets that built leverage during the pandemic may be more likely to correct if rates remain high for long, particularly where macroprudential policies did not prevent leverage buildup. - With a view to the next tightening cycle, prudential authorities should add instruments such as caps on debt-service-to-income ratios, if not already in place, to prevent financial-stability side effects of monetary policy. - Overarching conclusion: the longer rates are kept high, the greater the likelihood that households will "feel the pinch," even where they have so far been relatively sheltered. *Source: IMF staff, Chapter 2, World Economic Outlook — April 2024.* ### Introduction ### ch2 - Introduction ### Overview - Since late 2021, central banks around the world have raised policy interest rates at a speed, degree, and breadth unprecedented in at least 40 years to restore price stability. - Reopening-related supply-chain disruptions and the war in Ukraine hit post-lockdown economies with a series of supply shocks. These shocks, combined with extraordinarily supportive fiscal and monetary policies during the pandemic, supercharged inflation to levels not seen in decades. - Despite the sudden rise in interest rates, global growth proved surprisingly resilient in 2023; economic activity outpaced expectations in most countries, and employment remained robust while inflation retreated significantly. ### Research questions addressed in the chapter - Where are real estate and mortgage markets now? How have they evolved following the global financial crisis, the pandemic, and the recent monetary tightening? - Conceptually, what are the housing channels of monetary policy transmission? How are housing channels tied to mortgage and housing market characteristics? - How do the housing channels vary across countries? - Have the housing channels weakened in recent years? ### Methods and data (high-level) - Conceptual framework linking housing channels of monetary policy to mortgage and housing market characteristics. - Empirical methods follow Jordà (2005), Stock and Watson (2018), and Chen and others (2023). - New data used: - Monetary policy surprises against analyst predictions, to identify exogenous changes in interest rates. - Prevalence of fixed-rate mortgages across countries, from public sources and national authorities. - A new regional data set of house prices and real activity. - Model simulations assess joint effects of the prevalence of fixed-rate mortgages and regulatory loan-to-value (LTV) limits. ### Main findings — mortgage, housing, and transmission - Mortgage and real estate markets have undergone several shifts in the past few decades: - At the beginning of the recent hiking cycle and after a long period of low interest rates, mortgage interest payments were historically low, and the average maturity and share of mortgages subject to fixed rates were high in many countries. - Low rates, together with structural changes prompted by the pandemic and associated lockdowns, led to rapid growth in house prices. - Residential real estate prices are still well above prepandemic levels but have now stabilized and even declined in some economies in 2023. Country experiences vary widely. - The housing channels of monetary policy vary significantly across countries. Mortgage market characteristics matter: - Transmission is stronger where fixed-rate mortgages (FRMs) are less common. - Transmission is stronger where home buyers are more leveraged because of less-restrictive regulatory LTV limits. - Transmission is stronger where household debt is high. - Model simulations suggest these effects reinforce each other. Restrictive regulatory LTV limits and high household debt may dampen transmission more in the short term, delaying transmission. - Housing market characteristics also matter: - Transmission is stronger where housing supply is more restricted. - Transmission is stronger where house prices have recently been overvalued. - Some evidence that these two housing market characteristics strengthen transmission more when monetary policy is tightening than when it is loosening. - A high prevalence of FRMs dampens transmission more in a tightening cycle. - The housing channels have weakened in several countries recently: - Since the global financial crisis and during the pandemic, the prevalence of fixed-rate mortgages has increased, regulatory LTV limits have been tightened, and population has shifted to less-supply-constrained areas—changes that weaken housing channels. - These dampening forces are sometimes counterbalanced by increases in house prices in already-overvalued areas and in household debt, which would strengthen the effects of monetary policy. ### Context and stylized facts — Monetary tightening and real estate - Postpandemic tightening followed an extended period of low interest rates. In the immediate aftermath of the global financial crisis, central banks slashed interest rates globally; policy rates were kept low through the 2010s and were brought close to zero in advanced economies amid weak growth and low inflation. The pandemic prompted another round of policy rate cuts in 2020 and expanded asset purchase programs, keeping long-term rates low. - Many households took advantage of low interest rates to secure low-cost mortgages; at the start of the recent hiking cycle, effective mortgage rates had reached their lowest point in decades in many countries. - Example effective mortgage rates reached in early 2022: France 1.5 percent, Germany 1.7 percent, United States 3.3 percent, after declining from 4.0, 4.5, and 4.5 percent in 2011, respectively. - Low rates were accompanied by a shift to mortgages allowing fixed-interest payment periods and longer-dated mortgages; fixed-rate mortgages became more common. - Drawing lessons from the global financial crisis, many authorities tightened macroprudential policies related to housing financing in the 2010s, improving average creditworthiness and lowering leverage of households. - During the pandemic, the combination of low rates and structural changes led to rapid growth in house prices globally, often growing faster than income and lowering affordability: - House price growth combined with falling new construction boosted rents in many countries. - In some countries (for example, the United States) house prices rose more in suburbs than in high-density urban cores; in others (for example, Denmark, France, and the United Kingdom) prices in locations offering outdoor activities rose most, likely fueled by an increase in second-home purchases. - Pandemic-era changes in labor practices (such as remote work) created new headwinds for commercial real estate; price drops for offices were pronounced in the United States and have persisted since economies reopened. Rising borrowing costs add strains because preexisting low-rate loans will need refinancing over time. ### Empirical and policy caveats - Empirical analyses are constrained by data availability across economies and over time; for example, lack of data precludes the study of rents. - The chapter focuses narrowly on residential real estate and household mortgage characteristics, ignoring other channels of transmission (for example, banks or governments bearing interest rate risk). - It is not technically feasible to gather all characteristics within the same framework; analyses may not capture general equilibrium effects. ### Chapter structure (what follows) - Documentation of trends in mortgage and housing markets. - A conceptual framework relating effects of monetary policy to mortgage and housing market characteristics. - Evidence that monetary policy effects vary across countries because of those characteristics. - Assessment of whether the strength of housing channels has changed over time and lessons for monetary and macroprudential policymakers. *Source: ch2 - Introduction* ### Annex Figure 2.2.5). Meanwhile, elevated rates on ### ch2 - Annex Figure 2.2.5). Meanwhile, elevated rates on ### Overview - Elevated rates on new mortgages contributed to a drying up of housing transactions in most economies, particularly where homeowners had locked in mortgages with a low fixed rate and were reluctant to sell. - Since the beginning of the current hiking cycle: - Nominal house prices have declined in about a third of countries in the sample. - House prices remained elevated at the end of 2023 in most countries. - House prices and household consumption have evolved differently across countries; in some they rose together (for example, Colombia and Hungary) and in others they fell together (for example, Germany and Sweden). - House prices and residential investment together represent about 70 percent of GDP in most economies. ### The housing channels of monetary policy transmission (conceptual) - The chapter summarizes seven stylized channels (Figure 2.5) through which policy rates transmit via housing to household consumption and residential investment: 1. Cash flow channel: rising policy rates directly depress consumption of homeowners with adjustable-rate mortgages who cannot borrow easily. 2. Expectations/risk premium channel: changes in interest rates and expectations about future house prices affect demand for housing and mortgage pricing. 3. Wealth channel: falling house prices lower homeowners’ wealth and thus consumption. 4. Collateral channel: lower home values reduce collateral, restricting access to credit and lowering consumption. 5. Interest rate channel: higher policy rates lead to higher mortgage rates, reducing demand for credit and housing. 6. Bank lending channel: higher funding costs or lower deposits reduce bank lending. 7. Balance sheet channel: lenders reduce credit to riskier households anticipating lower borrower net worth and higher default risk. - The figure abstracts from second-round effects from consumption and investment back to house prices and credit and ignores effects on rents and unconventional monetary policy for clarity. - Additional mechanisms noted: - A risk-taking channel can amplify collateral effects when low-rate environments encourage more bank risk-taking. - Unconventional monetary policy (e.g., quantitative easing) may affect house prices via portfolio-rebalancing and expectations/risk premium channels. ### How housing characteristics modulate these channels - Channel interactions and where they are stronger: - The cash flow channel (1) is stronger where households are directly exposed to changes in mortgage rates and where the interest rate channel (5) is active — e.g., where fixed-rate mortgages are rare, household debt is higher, or loan-to-value limits are looser. - The expectations/risk premium channel (2) can be stronger where house prices have risen faster and preexisting overvaluation is greater, and where housing supply restrictions are larger. - The wealth and collateral channels (3 and 4) are more pronounced where household debt is higher and LTV limits are looser; effects are strengthened where housing supply restrictions are higher. - The interest rate channel (5) has more muted effects if regulatory loan-to-value limits are stricter, shifting borrowing toward wealthier households. - Other relevant factors (not exhaustively modeled here) include banking sector characteristics, housing policies (real estate taxes, rent subsidies), and prevalence of nonresident purchases. ### Heterogeneity across countries (empirical approach) - Empirical strategy: - Uses a local projections instrumental variable framework to map mortgage and housing market characteristics to monetary transmission. - Uses newly constructed monetary policy shocks based on deviations of actual rate decisions from analysts’ expectations. - Data and sample: - Country-level panel of 33 emerging market and advanced economies. - Regional data set (reduced number of countries) used to assess housing market characteristics separately. - Controls include time and country fixed effects and eight lags of changes in the dependent variable and other macroeconomic outcomes. - Sample coverage for some cross-country distributions: 1998:Q4 to 2023:Q1. ### Mortgage market characteristics studied - Three country-level mortgage market characteristics: 1. Share of fixed-rate mortgages (FRMs) in the stock of outstanding mortgages (FRMs defined as nominal payments that do not reset within a year). 2. Regulatory loan-to-value (LTV) limits on mortgages. 3. Ratio of household debt to GDP. - Cross-country heterogeneity examples and distributions: - FRMs are rare or nonexistent in some countries (for example, Finland and South Africa) and are the majority in others (Belgium, Mexico, and the United States). - Regulatory LTV limits can be as restrictive as 45 percent in Korea and as high as 100 percent or more in France, Germany, and the United States. - Household debt is below 50 percent of GDP in some countries (for example, Chile, Colombia, and Israel) and exceeds 100 percent of GDP in others (Australia, Canada, and Norway). ### Empirical findings on mortgage market characteristics - Fixed-rate mortgages (FRMs): - No significant differences found in the transmission of monetary policy to house prices between high-FRM and low-FRM countries. - A high share of FRMs significantly dampens the transmission of monetary policy to consumption relative to when FRMs are rare, with differences becoming significant after five quarters. - Interpretation: the cash flow channel is muted when mortgage payments do not adjust quickly due to FRMs, delaying interest-rate pass-through to household consumption. - LTV limits: - Differential effects of LTV limits on house prices and consumption are assessed by comparing “LTV restricted” (LTV limits below 100 percent) to “LTV not restricted” groups. - Household debt: - Differential effects of household debt on house prices and consumption are assessed by comparing “High household debt” (household debt to GDP above the sample median) to “Low household debt” groups. - Methodological notes on differential-effect figures (Figure 2.7): - Lines reflect cumulative percentage point responses to a 100 basis point change in policy rates. - Horizontal axes represent quarters (0–8). - Shaded areas represent 90 percent confidence intervals. - Groups: “High FRM” if share of FRMs is above the sample median, “Low FRM” otherwise; “LTV restricted” if LTV limits are below 100 percent, “LTV not restricted” otherwise; “High household debt” if household debt to GDP is above the sample median, “Low household debt” otherwise. - Diamonds indicate where differences between coefficients are statistically significant at least at the 10 percent level. ### Key statistics and precise numeric observations - House prices and residential investment together represent about 70 percent of GDP in most economies. - Since the beginning of the current hiking cycle, nominal house prices declined in about a third of countries in the sample. - House prices remained elevated at the end of 2023 in most countries. - Figure timing and samples: - Distribution of country-level changes measured between the quarter of the first country-level rate hike and 2023:Q2. - Cross-country distribution sample covers 1998:Q4 to 2023:Q1. - Examples of mortgage market extremes: - Korea: LTV limits as restrictive as 45 percent. - France, Germany, United States: LTV limits as high as 100 percent or more. - Household debt: below 50 percent of GDP in Chile, Colombia, Israel; exceeds 100 percent of GDP in Australia, Canada, Norway. - Empirical sample size: 33 emerging market and advanced economies. ### Policy-relevant implications - High prevalence of FRMs can delay and dampen the impact of monetary policy on household consumption (cash flow channel), reducing immediate effectiveness of rate hikes in curbing consumption. - Regulatory LTV limits and the level of household debt shape the strength of wealth and collateral channels, affecting how monetary policy transmits to consumption and house prices. - Cross-country heterogeneity in mortgage contract types, LTV regulation, and household indebtedness helps explain divergent housing and consumption outcomes amid a common global tightening cycle. - Identifying country-specific mortgage and housing characteristics is important for calibrating monetary and macroprudential policies to achieve desired macroeconomic outcomes without unintended distributional or financial stability consequences. *Source: IMF staff, Chapter 2, World Economic Outlook — April 2024.* ### CHAPTER 2 FEELINg THE PINCH? TRaCINg THE EFFECTS OF MONETaRy POLICy THROUgH HOUSINg MaRKETS ### CHAPTER 2 FEELINg THE PINCH? TRaCINg THE EFFECTS OF MONETaRy POLICy THROUgH HOUSINg MaRKETS ### Fixed-Rate Mortgages and the Timing of the Cash-Flow Channel - Many consumers do not feel the pinch of rising policy rates until the rate on their mortgage resets, which temporarily reduces the strength of the cash flow channel. - FRMs matter more when monetary policy is tightening: - When policy rates are lowered, borrowers with FRMs who can refinance may reduce monthly payments, lessening FRMs’ dampening effect on transmission. - When policy rates are rising, most borrowers with FRMs have no incentive to refinance and prefer to keep lower fixed payments, so FRMs more strongly limit transmission when policy is tightening. - Model and empirical references note asymmetry between tightening and loosening and cite Figure 2.8 for differential effects on consumption. ### LTV Limits, Household Indebtedness, and Monetary Policy Transmission - Tighter regulatory LTV limits delay monetary policy transmission and amplify differences in responses: - Example: Eight quarters after a 100 basis point increase (decline) in policy rates, house prices drop (rise) by 1 percentage point when LTV limits are restricted and by 4 percentage points when LTV limits are not restricted. - The effect on consumption materializes significantly faster when LTV limits are not restricted, though differences dissipate after four quarters; by the fourth quarter the effect when LTVs are restricted is about half of what it is when they are not. - Mechanisms and distributional effects: - Tighter LTV limits imply larger down payments and more acutely restrict poorer households’ borrowing; when LTVs are not restricted, borrower pools include poorer, more indebted households with higher marginal propensity to consume. - Cash-out refinancing is rare in most countries, so collateral and wealth channels are likely less relevant than the interest rate channel at the time of home purchases. - Household indebtedness strengthens and accelerates transmission: - Eight quarters after a change in monetary policy, nominal house prices respond about 3 percentage points more when household debt ratios are above the sample median relative to when they are below. - The consumption response to a monetary policy impulse is significantly faster if debt is higher, with statistical differences winding down after three quarters. ### Complementarity of FRMs and LTV Limits (Model Simulations) - Two-agent New Keynesian model with housing and leverage (Chen and others 2023) illustrates joint effects: - Transmission to household consumption is weakest under more restrictive LTV limits and highly prevalent FRMs. - Complementarity quantified in model simulations (responses to a 100 basis point change in policy rates): - Moving from high to low FRMs given loose LTV limits: transmission rises by 17 percent (red to yellow line). - Moving from high to low FRMs given tight LTV limits: transmission rises by 13 percent (blue to green line). - Moving from loose to tight LTV limits given low FRMs: transmission rises by 23 percent (green to yellow line). - Moving from loose to tight LTV limits given high FRMs: transmission rises by 19 percent (blue to red line). - Parameter definitions used in figure: Tight and loose LTV stand for LTV of 0.75 and 0.9, respectively. High and low FRM stand for a share of fixed-rate mortgages of 0.95 and 0.7, respectively. ### Local Housing Market Characteristics: Supply Constraints and Overvaluation - Housing supply restrictions (proxied by population density) strengthen transmission: - Following a 100 basis point tightening (loosening), nominal house prices decline (rise) by an additional 3 percentage points after eight quarters in areas with restricted housing supply compared with less-restricted areas. - Real GDP per capita undergoes an additional decline (rise) of 2 percentage points at peak in supply-restricted regions. - The house-price effect is 50 percent larger than the average effect of monetary policy on house prices; the GDP per capita effect is about one-third larger than corresponding average effects. - Effects in supply-restricted regions are more back-loaded. - Recent house price overvaluation strengthens transmission: - Following a 100 basis point tightening (loosening), the peak fall (rise) in nominal house prices is 1.5 percentage points greater in areas with recent house price overvaluation relative to those without. - Real GDP per capita declines (rises) an extra 1 percentage point in regions with recent overvaluation (about two-thirds of the average effect). - The differential effect is back-loaded for GDP per capita; house price differentials peak at about five quarters. - These patterns reflect expectations, collateral, and wealth channels, and overvaluation is often accompanied by excessive leverage and spirals of falling prices and foreclosures when policy tightens. ### Asymmetry and Timing: Tightening vs Loosening - Supply constraints and price overvaluation matter more when monetary policy tightens, though symmetry can be rejected only for house prices and in the first two quarters in the tested specification. - One explanation: the leverage distribution means fewer households become borrowing unconstrained after easing than become more constrained after tightening. ### Cross-Country and Regional Variation - Heat map (based on 2022 data or latest available) shows substantial cross-country variation in transmission strength across five axes: share of fixed-rate mortgages, regulatory LTV limits, household debt, housing supply restrictions, and house price overvaluations. - Darker reds indicate stronger housing-channel transmission relative to cross-country distribution; lighter reds indicate weaker transmission. - Examples noted: - Australia and Japan appear to have stronger housing channels: low shares of fixed-rate mortgages, less-restrictive LTV limits, high household debt (Japan only to some extent), and an elevated proportion of population in supply-restricted areas. - Colombia, Hungary, and Israel are more likely to exhibit weaker transmission, with notably low levels of household debt and supply constraints. - Caveats: - Columns in the heat map cannot be compared or aggregated for each country; the figure focuses only on housing channels and not on other channels (for example, exchange rate channel for emerging and highly open economies). - The heat map ranking broadly lines up with actual changes in house prices and real consumption since the start of each country’s most recent hiking cycle, though other shocks also drive outcomes. ### Evolving Mortgage and Housing Market Characteristics - Mortgage market characteristics have changed since the global financial crisis: - Fixed-rate mortgages have become more prevalent (Figure 2.13), with the increase driven by low rates. - Regulatory LTV limits have either tightened or remained stable. *Source: CHAPTER 2 FEELINg THE PINCH? TRaCINg THE EFFECTS OF MONETaRy POLICy THROUgH HOUSINg MaRKETS (PDF).* ### Annex Figure 2.2.6). Household debt ratios have ### Annex Figure 2.2.6). Household debt ratios have ### Changes in household debt and housing markets - Household debt ratios increased in some countries, notably Chile, France, and Korea, but decreased in others, such as Denmark, Ireland, and Spain (Online Annex Figure 2.2.7). - Housing markets underwent notable changes particularly during the pandemic (Online Annex Figure 2.2.8). - In most countries analyzed, national-level housing supply is now likely to be more elastic as a result of migration from densely populated urban areas to less dense rural or suburban areas during the pandemic years. - House price overvaluation changes were more balanced: - In some countries, areas that were overvalued in 2019 have seen stagnant or declining price-to-income ratios (for example, Finland and Hungary), contributing to a more even distribution of valuations across regions within a country. - In other countries, house price overvaluation has risen precisely where house prices were already overvalued (for example, Mexico and The Netherlands). ### Heterogeneity in monetary policy transmission through housing - The chapter ranks countries by overall strength of transmission using five criteria: Fixed-Rate Mortgages (FRM), LTV limits, household (HH) debt, supply constraints, and overvaluation. - Fixed-rate mortgages are measured as the share of the total outstanding stock, 2022:Q4 (or latest available). Fixed-rate mortgages exclude mortgages that adjust to inflation (as in Chile). - LTV limits are the regulatory loan-to-value limits, averaged across all mortgage types, 2021:Q4. - HH debt is the household credit-to-GDP ratio, 2022:Q4. - Supply constraints are the proportion of population living in areas with high population density, 2022:Q4 (or latest available). Regions above the 90th percentile of population density within each country are defined as high-population-density areas. - Overvaluation is the median price-to-income ratio (PIR) in overvalued areas, 2022:Q4 (or latest available). A region is defined as overvalued if its PIR is above the 75th percentile of its regional time series. - For each of the five criteria, countries obtain a score between 1 and 4 (or between 1 and 3 in change-based analysis) reflecting their percentile in the cross-country distribution. Judgment is used for borderline cases. - Changes in mortgage market characteristics between 2011 and 2022:Q4 and housing-market characteristics between 2019 and 2022 are summarized to indicate strengthening or weakening of transmission: - Shades of blue indicate changes implying weakening of monetary policy transmission; shades of red indicate strengthening; gray indicates no change. - Fixed-rate mortgages are measured as the change in share from 2011:Q1 (or earliest available) to 2022:Q4 (or latest available). LTV limits are the change from 2011:Q1 to 2021:Q4. HH debt is the change in household credit-to-GDP ratio from 2011:Q1 to 2022:Q4. Supply constraints are the population growth differential between areas with high and low population density from 2019:Q4 to 2022:Q4 (or latest available). Overvaluation is the median PIR growth differential between overvalued and nonovervalued areas from 2019:Q4 to 2022:Q4 (or latest available). - Countries are listed and ranked in the same order as Figure 2.12, with strongest transmission at the top and weakest at the bottom. ### Key country-level developments and aggregate implications - Changes suggesting stronger transmission (example countries): Canada, Chile, Japan — driven mainly by a declining or stable share of FRMs, an increase in debt, and more constrained housing supply. - Changes suggesting weaker transmission (example countries): Hungary, Ireland, Portugal, United States — characteristics moved in the opposite direction. - At the global level, the heat map points to a decline in transmission of monetary policy through the cash flow, wealth, and collateral channels, with contributing factors including: - Increased adoption of fixed-rate mortgages. - Tighter LTV limits. - Lower household debt in some countries. - Outmigration from densely populated areas. - House price deflation in some previously overvalued areas. - The heat map focuses only on housing channels and therefore gives a partial view of changing transmission; policy-rate movements over the last two years (speed, degree, breadth) may also have affected overall transmission. ### Interest-rate pass-through and regional cases - Box 2.1 (Europe): Pass-through from policy rates to bank interest rates has been heterogeneous across types of interest rates in the postpandemic tightening cycle. - Pass-through seems highest to time deposits, followed by mortgages and loans to nonfinancial corporations. - Relative to past cycles, pass-through in Europe has weakened somewhat, except for nonfinancial corporation time deposits and loans. - The annual increase in mortgage-servicing costs relative to mid-2022 varies across the euro area, from Portugal at 1.2 percent of GDP to Malta at virtually zero. - Box 2.2 (China): Transmission from policy rates to the real economy through the housing market has been weak during the recent property downturn. - Before the downturn, lower short-term borrowing costs were followed by accelerating house price growth, suggesting policy-rate influence via expectations/risk premium and credit channels. - Since mid-2021, the relationship between house prices and borrowing costs weakened as nonmonetary factors (developer distress, large inventories of unfinished homes) dominated housing dynamics. - Changes in short-term interest rates have had a muted impact on consumption, indicating limited transmission through wealth and collateral channels. - Regulatory mortgage loan-to-value limits at 60 percent are close to the 10th percentile in a cross-country comparison, further weakening collateral-channel sensitivity. - Recent monetary policy easing via multiple rate cuts had limited impact on housing-related interest rates; a one-time mortgage rate cut was undertaken in September 2023. - Recommendation: Increasing reliance on interest-rate-based tools (as opposed to greater reliance on credit policies) would help improve policy transmission via the housing channel. ### Policy implications and recommendations - Macroprudential context: - Tighter borrower-based macroprudential regulation improves financial and economic stability; monetary policy may have smaller effects in countries with relatively tight regulation because borrowers are on average less leveraged and less sensitive to changing interest rates. - This cushioning effect is desirable insofar as it allows monetary policy to focus on managing aggregate demand and price pressures without precipitating a financial crunch. - Monetary policy implications: - A deep, country-specific understanding of housing channels is important for calibrating and adjusting monetary policy. - In countries where housing channels are strong, monitoring housing market developments and changes in household debt service can help identify early signs of overtightening. - Where transmission is weak, more forceful early action can be taken when signs of overheating and inflationary pressures first emerge. - Risks and prudential recommendations: - Despite wider adoption of fixed-rate mortgages, fixation periods are often short; as rates on these mortgages reset over time, monetary policy transmission could suddenly become more effective and depress consumption. - Financial instability could follow if defaults rise abruptly, especially where households are highly indebted or bankruptcy laws favor borrowers. - Overvalued markets that built leverage during the pandemic may be more likely to correct if rates remain high for long, particularly where macroprudential policies did not prevent leverage buildup. - With a view to the next tightening cycle, prudential authorities should add instruments such as caps on debt-service-to-income ratios, if not already in place, to prevent financial-stability side effects of monetary policy. - overarching conclusion: - The longer rates are kept high, the greater the likelihood that households will "feel the pinch," even where they have so far been relatively sheltered. *International Monetary Fund | April 2024 — CHAPTER 2 FEELING THE PINCH? 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