Two recent papers, using heterogeneous agent models, analyze how monetary policy transmits through the housing markets. The first paper by the ECB looks at Euro Area countries and focuses on liquidity-constrained vs. unconstrained households while the second paper by the Bank of England looks at the UK housing market and focuses on landlord behavior.
Monetary policy transmission with adjustable-rate mortgages in the Euro Area
Giovanni Sciacovelli examines why monetary policy transmission varies dramatically across Euro Area countries (Irish consumption reacts 10x more than French consumption to policy shocks) by focusing on the interaction between adjustable-rate mortgages (ARMs) and household financial constraints. He uses local projections across 10 Euro Area countries (1999-2019) and panel regressions to test how adjustable-rate-mortgages (ARM) prevalence and hand-to-mouth (HtM) household shares jointly affect transmission strength. Sciacovelli develops a Heterogeneous-Agent New Keynesian (HANK) model with housing/mortgage choices, and accommodates different levels of ARMs and MPCs.
- Critical interaction effect
Conventional wisdom holds that adjustable-rate mortgages (ARMs) alone determine monetary policy transmission strength, but this view is fundamentally incomplete. The research reveals that the interaction between ARM prevalence and the presence of liquidity-constrained households is what truly drives transmission effectiveness across Euro Area countries.
- Transmission mechanism
The underlying mechanism reveals why this interaction is so powerful. When central banks raise interest rates, households with adjustable-rate mortgages face immediate increases in their monthly mortgage payments, directly reducing their disposable income available for consumption. However, the consumption response depends critically on the marginal propensity to consume of the affected households. High-MPC households, who are typically lower-income and liquidity-constrained, must make sharp consumption adjustments when their mortgage payments rise because they lack sufficient liquid savings to smooth through the shock. In contrast, low-MPC households, who are typically wealthier with substantial financial buffers, barely alter their consumption patterns despite experiencing similar increases in mortgage payments.
- Quantitative performance
The theoretical model quantifies this mechanism with remarkable precision, explaining 46% of the observed cross-country transmission differences across Euro Area economies. The decomposition reveals that MPC differences account for the largest component at 26% of explained variation, while ARM prevalence alone contributes only 9%, and their crucial interaction accounts for the remaining 11%.
Perhaps most importantly for policymakers, the distribution of ARMs across income levels matters enormously. Even holding the overall ARM share constant, transmission strength is 1.6 times stronger when adjustable-rate mortgages are concentrated among low-income, high-MPC households rather than dispersed across all income levels. This finding underscores that central banks and financial regulators must look beyond aggregate ARM statistics to understand how effectively monetary policy will transmit through the mortgage channel in their jurisdictions.
Monetary Policy Transmission Through Adjustable-Rate Mortgages in the Euro Area
Author: Giovanni Sciacovelli
From: Northwestern University
Monetary policy transmission: house prices vs rents
This paper by Daniel Albuquerque, Thomas Lazarowicz, and Jamie Lenney examines how monetary policy affects housing markets and rent prices using UK data. The authors employ two complementary approaches. First, they use a Structural Vector AutoRegression (SVAR) model with high-frequency monetary policy identification to analyze UK housing market responses from 1997-2023. Second, they develop a Heterogeneous Agent New Keynesian (HANK) model that uniquely incorporates individual private landlords as the marginal rental housing suppliers, departing from the typical assumption of commercial rental entities.
- Key empirical findings
The core empirical discovery is that house prices and rents respond very differently to monetary policy shocks. When interest rates rise by 1 percentage point, house prices fall gradually by about 6% over 16 months in a hump-shaped pattern. However, nominal rents remain remarkably stable for 1-2 years before eventually declining. This divergent response is robust across UK regions and housing types. Housing market activity also drops significantly, with sales falling over 20% and younger households (ages 20-35) increasingly remaining in rental markets.
- Theoretical insights
The model reveals that housing accounts for approximately 50% of monetary policy’s impact on consumption at peak transmission. The effects vary dramatically by housing tenure: mortgagors experience the largest consumption drops due to higher borrowing costs and falling property values, while outright homeowners are least affected due to their liquid asset buffers. Surprisingly, landlords are the second-most affected group because many hold negative liquid asset positions and fail to adequately pass through mortgage cost increases to tenants, behaving like “wealthy hand-to-mouth” households.
- Critical role of expectations
The research demonstrates that deviations from rational expectations are essential for matching empirical patterns. The model requires a combination of sticky and extrapolative expectations, where households update their forecasts infrequently but extrapolate from recent trends when they do adjust. This behavioral framework generates the observed under-reaction in the short term followed by over-reaction in the medium term.
- Policy implications
The paper highlights important cross-country differences in rental market structure. When the model substitutes individual landlords with rational commercial entities (as more common in the US), rental prices increase substantially after rate hikes, creating greater policy trade-offs. For housing supply shocks, the analysis suggests policymakers may optimally “look through” housing market disruptions and focus on non-housing inflation, as targeting total CPI including rents requires very large interest rate increases that create substantial output gaps.
Monetary Transmission Through the Housing Sector
Authors: Daniel Albuquerque, Thomas Lazarowicz, Jamie Lenney
From: Bank of England, University College, London
