The Mortgage Cash Flow Channel of Monetary Policy Transmission: A Tale of Two Countries 
How does monetary policy affect household consumption? This paper offers insights into the mortgage cash flow effect—that is, the change in consumption due to a change in mortgage rates—by comparing monetary policy transmission in two countries with different mortgage market institutions. The countries studied are Spain, where most households hold true adjustable-rate mortgages (ARMs) with automatic annual resets, and the United States, where the mortgage market is dominated by fixed-rate mortgages (FRMs) and where ARMs typically have an extended initial fixed term of 5 to 10 years. The authors use data from the Encuesta de Presupuestos Familiares–Base 2006 for Spain and the Consumer Expenditure Survey for the United States to empirically analyze the mortgage cash flow effect from 2007 to 2018.
Key Findings
- The authors find a larger effect of mortgage rate changes on spending in the United States than in Spain. A 1 percentage point (p.p.) decrease in the mortgage rate led to 1.65 p.p. higher expenditure growth in Spain, compared with 2.8 p.p. higher expenditure growth in the United States.
- Within each country, the authors find a negative relationship between mortgage rate changes and expenditure growth, not just for homeowners with a mortgage (mortgagors) but also for outright homeowners and renters.
- Even among mortgagors, the spending response to mortgage rate declines is surprisingly larger in the United States than in Spain.
- In Spain, the effect of mortgage rate changes is symmetric, while in the United States, mortgage rate decreases have a larger effect on consumption than rate increases. The consumption response in Spain is homogeneous across mortgagors with different demographic and economic characteristics, while in the United States it is heterogeneous across mortgagors. In the United States, effects are largest for mortgagors who have likely refinanced their mortgages or who have experienced a recent large decline in interest rates.
Implications
The counterintuitively larger effect of mortgage rate changes under the primarily FRM mortgage market in the United States could be driven by two factors: abundant refinancing during the sample period and by the fact that mortgage rates co-move with other interest rates. Other channels of monetary policy transmission to consumption, including non-mortgage cash flow effects and intertemporal substitution effects, may impact the expenditure of households with or without mortgages. The paper further demonstrates that the institutional structure of mortgages may matter beyond the average effect of monetary policy on consumption. Given the automatic transmission of rate changes under ARMs versus the selective transmission under FRMs based on who refinances, this structure has potential indirect consequences for inequality.
Abstract
We study the mortgage cash flow channel of monetary policy transmission under fixed-rate mortgage (FRM) versus adjustable-rate mortgage (ARM) regimes by comparing the United States with primarily long-term FRMs and Spain with primarily ARMs that automatically reset annually. We find a robust transmission of mortgage rate changes to spending in both countries but surprisingly a larger effect in the United States—and provide two explanations for this finding. First, there are channels of transmission other than the mortgage cash flow effect since other interest rates co-move with the mortgage rate. Second, while mortgage resets in Spain are automatic and typically small, mortgagors in the United States must actively refinance to lock in lower rates. As a result, the mortgage cash flow effect in Spain is homogeneous across mortgagors and symmetric for rate increases and decreases, whereas in the United States the effect is largest when rates decline, especially for households identified as likely refinancers.