Central banks have raised interest rates significantly over the past two years to combat post-pandemic inflation. Many thought this would lead to a slowdown in economic activity. Yet, global growth has held broadly steady, with deceleration only materializing in some countries.
Why are some feeling the pinch from higher rates and not others? The answer partly lies in differences in mortgage and housing market characteristics. The effects of rising monetary policy rates on activity partly depend on housing and mortgage market characteristics, which vary significantly across countries, as we show in a chapter of our latest World Economic Outlook.
Housing is an important channel of monetary policy transmission. Mortgages are the largest liability for households, with housing often serving as their only significant form of wealth. Real estate also accounts for a large share of consumption, investment, employment, and consumer prices in most economies.
To assess how key housing characteristics impact the effects of monetary policy on activity, our research leverages new data on housing and mortgage markets compiled across countries: we find that those characteristics vary significantly across countries. For example, the share of fixed-rate mortgages in all country-level mortgages can vary from close to zero in South Africa to more than 95 percent in Mexico or the United States.
Our results indicate that monetary policy has greater effects on activity in countries where the share of fixed-rate mortgages is low. This is due to homeowners seeing their monthly payments rise with monetary policy rates if their mortgage rates adjust. By contrast, households with fixed-rate mortgages will not see any immediate difference in their monthly payments when policy rates change.
The effects of monetary policy are also stronger in countries where mortgages are larger compared to home values, and in countries where household debt is high as a share of GDP. In such settings, more households will be exposed to changes in mortgage rates, and the effects will be stronger if their debt is higher relative to their assets.
Housing market characteristics also matter: the transmission of monetary policy is stronger where housing supply is more restricted. For example, lower rates will decrease borrowing costs for first-time home buyers and increase demand. Where supply is restricted, this will lead to home price appreciation. Existing owners will see their wealth increase as a result, leading them to consume more, including if they can use their home as collateral to borrow more.
The same holds true where home prices have recently been overvalued. Sharp price increases are often driven by overly optimistic views about future house prices. These are typically accompanied by excessive leverage, prompting spirals of falling home prices and foreclosures when monetary policy tightens, which can lead to starker income and consumption declines.
Weaker housing transmission
Mortgage and real estate markets have undergone several shifts since the global financial crisis and the pandemic. At the beginning of the recent hiking cycle and after a long period of low interest rates, mortgage interest payments were historically low, the average maturity was long, and the average share of fixed-rate mortgages was high in many countries. In addition, the pandemic led to population shifts away from city centers and to relatively less-supply-constrained areas.
As a result, the housing channels of monetary policy may have weakened, or at least been delayed, in several countries.
Country experiences vary widely. Changes in mortgage market characteristics in countries such as Canada and Japan suggest a strengthening of the transmission of monetary policy through housing. This is driven mainly by a declining share of fixed-rate mortgages, an increase in debt, and more constrained housing supply. By contrast, transmission seems to have weakened in countries such as Hungary, Ireland, Portugal, and the United States, where characteristics have moved in the opposite direction.
Calibrating policy
Our findings suggest that a deep, country-specific understanding of housing channels is important to help calibrate and adjust monetary policy. In countries where the housing channels are strong, monitoring housing market developments and changes in household debt service can help identify early signs of overtightening. Where monetary policy transmission is weak, more forceful early action can be taken when signs of overheating and inflationary pressures first emerge.
What about now? Most central banks have made significant progress toward their inflation target. It could follow from the discussion that, if transmission is weak, erring on the side of too much tightening is always less costly. However, overtightening, or leaving rates higher for longer, could nevertheless be a greater risk now.
While fixed-rate mortgages have indeed become more common in many countries, fixation periods are often short. Over time, and as rates on these mortgages reset, monetary policy transmission could suddenly become more effective and so depress consumption, especially where households are heavily indebted.
The longer time rates are kept high, the greater the likelihood that households will feel the pinch, even where they have so far been relatively sheltered.
—This blog is based on Chapter 2 of the April 2024 World Economic Outlook, “Feeling the pinch? Tracing the effects of monetary policy through housing markets.” The authors of the chapter are Mehdi Benatiya Andaloussi, Nina Biljanovska, Alessia De Stefani, and Rui Mano with support from Ariadne Checo de los Santos, Eduardo Espuny Diaz, Pedro Gagliardi, Gianluca Yong, and Jiaqi Zhao. Amir Kermani was an external consultant and Jesper Lindé consulted on the modeling.
