The Mortgage Cash-Flow Channel: How Rising Interest Rates Impact Household Consumption

TL;DR

This paper examines how rising interest rates affect household consumption through mortgage cash-flow constraints, using Israeli microdata and a quasi-experimental design to reveal differential impacts across income groups.

Contribution

It provides empirical evidence of the mortgage cash-flow channel's role in monetary policy transmission, especially among lower-income households with adjustable-rate mortgages.

Findings

Higher ARMs exposure leads to greater consumption reduction.

Mid- to lower-income households are more affected.

Mortgage payment ratios significantly influence consumption decline.

Abstract

This study investigates the impact of increased debt servicing costs on household consumption resulting from monetary policy tightening. It utilizes observational panel microdata on all mortgage holders in Israel and leverages quasi-exogenous variation in exposure to adjustable-rate mortgages (ARMs) due to a regulatory shift. Our analysis indicates that when monetary policy became more restrictive, consumers with a higher ratio of ARMs experienced a more marked reduction in their consumption patterns. This effect is predominantly observed in mid- to lower-income households and those with a higher ratio of mortgage payments to total spending. These findings highlight the substantial role of the mortgage cash-flow channel in monetary policy transmission, emphasizing its implications for economic stability and inequality.