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Mortgage Markets, Collateral Constraints, and Monetary Policy: Do Institutional Factors Matter?

The role of housing wealth on economic activity has recently attracted considerable attention among academic researchers, policy-makers and press commentators. This attention is partly explained by the sizeable rises in property prices and household indebtedness in several industrialized countries over recent years (Debelle (2004), Terrones and Otrok (2004)) and the need to understand both the determinants of such rises and their potential implications for monetary policy and financial stability. Beyond these policy considerations, there is growing interest in the effects of changes in property prices on consumption decisions, given the predominance of housing in total household wealth (Campbell and Cocco (2003)).

This paper studies the role of institutional characteristics of mortgage markets across the main industrialized countries, with particular focus on EU countries, in determining the channels of monetary policy transmission. We begin by establishing two facts on the relationship between mortgage markets, consumption and house prices. First, there is significant heterogeneity in the institutional characteristics of national mortgage markets across the main industrialized countries, and especially within the EU.

Examples of such institutional characteristics include the typical duration of mortgage contracts, the required levels of down-payment, the existence (or lack thereof) of equity release products, and the interest-rate structure of mortgage contracts (e.g., variable vs. fixed rate). We interpret these indicators as measures of the degree of development/flexibility of mortgage markets. Second, the correlation between private consumption and house prices at the business cycle frequency is related to mortgage markets characteristics, with that correlation being larger in countries featuring more developed mortgage markets.

We then conduct a VAR-based analysis of the effects of monetary policy shocks on consumption and house prices in a sample of euro area countries, with the addition of Canada, the U.K. and the U.S.. We find significant heterogeneity in both the timing and strength of those effects across countries. In particular, we find that the size of the peak effect of a monetary policy shock on consumption and real house prices is positively related to indicators of development/flexibility in mortgage markets, such as the mortgage debt to GDP ratio, the loan-to-value (LTV henceforth) ratio, and the existence of equity release products.

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Mortgage Markets, Collateral Constraints, and Monetary Policy: Do Institutional Factors Matter?