Long-Term Debt and Short-Term Rates: Fixed-Rate Mortgages and Monetary Transmission

This paper uses instrumental-variable local projections (IV-LP) on an unbalanced panel of up to 35 countries over approximately two decades to establish two interconnected findings about fixed-rate mortgages (FRMs) and monetary policy. First, monetary policy affects mortgage type selection: a 100 basis point tightening increases the share of adjustable-rate mortgages (ARMs) in new originations by approximately 10 percentage points after one year, while easing generates the reverse shift toward FRMs. The mechanism is budget constraints: ARM rates move nearly one-for-one with policy rates while FRM rates respond by only about 0.5 percentage points per 100 bps, so after tightening the FRM-ARM spread narrows but both products become more expensive — households facing tighter budgets select the cheaper ARM option, irrespective of spread comparisons. Second, the prevailing stock composition of outstanding ARMs determines how strongly monetary policy transmits to real activity: for every additional percentage point of household debt held as ARMs, the same 100 bps policy change produces approximately 0.05 percentage points more impact on real private consumption at six quarters ahead, controlling for the level of household debt-to-GDP. A back-of-the-envelope calculation implies that the same 100 bps change induces a consumption response approximately 5 percentage points stronger in an economy with 100 percent ARMs versus one with only FRMs. These two findings jointly imply that FRMs create both path-dependency (past easing cycles populate the stock with FRMs, weakening future transmission) and state-dependency (current FRM prevalence determines how much a given rate change moves consumption and GDP) in monetary policy.

Alessia De Stefani | Macro Paper Warehouse

Long-Term Debt and Short-Term Rates: Fixed-Rate Mortgages and Monetary Transmission