Asymmetric Effects on Financial Cycles in a Monetary Union with Diverging Country Preferences for Variable- and Fixed-Rate Mortgages

Before as well as at the time when the European Monetary Union (EMU) was launched, a number of economists were discussing possible asymmetrical effects of monetary transmission stemming from apparent structural differences between national credit markets. On the one hand, they hoped that the single currency would lead to a process of harmonization and on the other hand, they focused on asymmetric effects on output and inflation. In the current article, it will be argued that, additionally, consideration needs to be given to an asymmetrical impact on the national financial cycles in a monetary union. This is especially true given a diverging prevalence of variable-rate and fixed-rate mortgages, as can be observed within the EMU. We propose a "new credit channel" and an "interest burden channel" as analytical concepts for a better understanding of such effects. These working hypotheses will be constructed using (formally) stylized transmission channels and hardened by stylized facts for the euro area. Our main findings based on stylized facts are that, first of all, average initial interest rates for newly originated mortgages in Ireland and Spain - as countries with a prevalence of variable-rate contracts - were 1.2 percentage points lower from 2003 to 2005 in comparison to Germany. This may have supported a development towards a "debt sustainability-illusion" in these countries. Secondly, aggregated interest payments for mortgages doubled in Ireland and Spain as a percentage of GDP from 2005 to 2008. In the end, the results may imply that countries with predominantly variable rate mortgages are ceteris paribus more likely to need macroprudential policy activities in the first place and do so with a higher intervention frequency than their EMU counterparts with a prevalence of fixed-rate mortgages.