Central banks have implemented substantial interest rate hikes over the past two years to address inflation, which surged following the COVID-19 pandemic.
Despite widespread expectations that these rate increases would slow economic activity, global growth has remained relatively steady, with notable deceleration only occurring in certain countries.
The varied impact of rising rates on different economies can be partly attributed to differences in mortgage and housing market characteristics, according to the latest World Economic Outlook.
Housing markets play a pivotal role in the transmission of monetary policy. Mortgages, as a substantial liability for households, and real estate, as a key factor in consumption, investment, employment, and consumer prices, underscore the importance of understanding housing market dynamics.
Research reveals that rising interest rates affect housing market characteristics, which vary significantly across countries.
For instance, the proportion of fixed-rate mortgages can range from nearly zero in South Africa to over 95 percent in Mexico and the United States.
Countries with a lower share of fixed-rate mortgages experience more significant immediate impacts from monetary policy changes, as homeowners with adjustable-rate mortgages face higher monthly payments when rates rise.
Conversely, those with fixed-rate mortgages see that their payments remain the same.
The impact of monetary policy is also more pronounced in countries where mortgages constitute a more significant portion of home values and regions with high household debt relative to GDP.
In such environments, a higher proportion of households are exposed to fluctuations in mortgage rates, exacerbating the effects when their debt levels are high compared to their assets.
Housing market dynamics further influence monetary policy transmission.
In countries with restricted housing supply, lower interest rates can spur demand from first-time buyers, leading to higher home prices and increased wealth for existing homeowners.
This wealth effect can drive higher consumption, mainly if homeowners use their properties as collateral for additional borrowing.
Conversely, in areas where home prices have recently been inflated due to overly optimistic forecasts and excessive leverage, tightening monetary policy can trigger declines in home prices and increase foreclosures, leading to sharper reductions in income and consumption.
Since the global financial crisis and the pandemic, mortgage and real estate markets have experienced significant changes. Initially, mortgage interest payments were historically low, and a high share of fixed-rate mortgages was common.
However, the pandemic has led to shifts in population and changes in housing supply dynamics, potentially weakening the immediate effects of monetary policy in some regions.
Country-specific experiences vary widely. In Canada and Japan, for example, a decline in the share of fixed-rate mortgages, increased debt, and more constrained housing supply suggest strengthening monetary policy transmission.
In contrast, countries such as Hungary, Ireland, Portugal, and the United States have seen weakened transmission due to differing mortgage market characteristics.
The findings underscore the importance of understanding housing market dynamics to calibrate monetary policy effectively.
In countries with robust housing transmission, early identification of signs of overtightening through vigilant monitoring of the housing market and household debt developments is crucial to prevent potential economic disruptions.
Conversely, more decisive actions may be necessary in regions with weaker transmission to address emerging inflationary pressures.
As central banks progress toward their inflation targets, the risk of ‘overtightening ‘, which refers to a situation where monetary policy is too restrictive, remains a concern.
Although fixed-rate mortgages are becoming more common, their shorter fixation periods may result in more pronounced effects from monetary policy changes, particularly in heavily indebted households.
Therefore, the potential impact of prolonged high interest rates on households, even those currently experiencing relatively stable conditions, should be a significant consideration for policymakers.