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How does monetary policy pass-through affect mortgage default? Evidence from the Irish mortgage market

Author

Listed:
  • Byrne, David

    (Central Bank of Ireland)

  • Kelly, Robert

    (Central Bank of Ireland)

  • O'Toole, Conor

    (Central Bank of Ireland)

Abstract

One channel through which monetary policy can affect loan default in the mortgage market is by altering the affordability of borrower repayments. Quantifying the exact impact of this relationship is complex as it depends on both the structure and passthrough of a given mortgage market. This paper uses a quasi-natural experiment to identify the impact of changes in interest rates on mortgage default. Using a panel of loan level administrative data for Ireland, we deal with selection bias that is inherent in identifying the impact of interest rates by exploiting the variation between two types of adjustable rate mortgage that were offered to Irish borrowers for a particular period in the mid-2000s. We map changes in interest rates to default by quantifying the direct effect through changes in borrower installments. Using a pass-through approach, we find a strong and highly statistically significant impact of interest rates on mortgage default, with a 1 per cent reduction in installment associated with a 5.8 per cent decrease in the likelihood of default over the following year. We also find evidence that negative equity offsets the some of the gains arising from lower policy rates indicating an interaction between monetary policy and asset price shocks in the mortgage market.

Suggested Citation

  • Byrne, David & Kelly, Robert & O'Toole, Conor, 2017. "How does monetary policy pass-through affect mortgage default? Evidence from the Irish mortgage market," Research Technical Papers 04/RT/17, Central Bank of Ireland.
  • Handle: RePEc:cbi:wpaper:04/rt/17
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    File URL: https://www.centralbank.ie/docs/default-source/publications/research-technical-papers/04rt17-how-does-monetary-policy-pass-through-affect-mortgage-default.pdf?sfvrsn=6
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    References listed on IDEAS

    as
    1. Kelly, Robert & O’Malley, Terence, 2016. "The good, the bad and the impaired: A credit risk model of the Irish mortgage market," Journal of Financial Stability, Elsevier, vol. 22(C), pages 1-9.
    2. John Y. Campbell & João F. Cocco, 2003. "Household Risk Management and Optimal Mortgage Choice," The Quarterly Journal of Economics, Oxford University Press, vol. 118(4), pages 1449-1494.
    3. Hristov, Nikolay & Hülsewig, Oliver & Wollmershäuser, Timo, 2014. "The interest rate pass-through in the Euro area during the global financial crisis," Journal of Banking & Finance, Elsevier, vol. 48(C), pages 104-119.
    4. Foote, Christopher L. & Gerardi, Kristopher & Goette, Lorenz & Willen, Paul S., 2008. "Just the facts: An initial analysis of subprime's role in the housing crisis," Journal of Housing Economics, Elsevier, vol. 17(4), pages 291-305, December.
    5. Atif Mian & Amir Sufi, 2009. "The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis," The Quarterly Journal of Economics, Oxford University Press, vol. 124(4), pages 1449-1496.
    6. Haughwout, Andrew & Peach, Richard & Tracy, Joseph, 2008. "Juvenile delinquent mortgages: Bad credit or bad economy?," Journal of Urban Economics, Elsevier, vol. 64(2), pages 246-257, September.
    7. Philomena M. Bacon & Peter G. Moffatt, 2012. "Mortgage Choice as a Natural Field Experiment on Choice under Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(7), pages 1401-1426, October.
    8. Guido W. Imbens & Jeffrey M. Wooldridge, 2009. "Recent Developments in the Econometrics of Program Evaluation," Journal of Economic Literature, American Economic Association, vol. 47(1), pages 5-86, March.
    9. Christopher Mayer & Karen Pence & Shane M. Sherlund, 2009. "The Rise in Mortgage Defaults," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 27-50, Winter.
    10. Wooldridge, Jeffrey M., 2007. "Inverse probability weighted estimation for general missing data problems," Journal of Econometrics, Elsevier, vol. 141(2), pages 1281-1301, December.
    11. Gregory E. Elliehausen & Min Hwang, 2010. "Mortgage contract choice in subprime mortgage markets," Finance and Economics Discussion Series 2010-53, Board of Governors of the Federal Reserve System (US).
    12. Geetesh Bhardwaj & Rajdeep Sengupta, 2011. "Credit scoring and loan default," Working Papers 2011-040, Federal Reserve Bank of St. Louis.
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    Citations

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    Cited by:

    1. Kelly, Jane & Le Blanc, Julia & Lydon, Reamonn, 2018. "Pockets of risk in European Housing Markets: then and now," Research Technical Papers 12/RT/18, Central Bank of Ireland.
    2. Slaymaker, Rachel & O'Toole, Conor & McQuinn, Kieran & Fahy, Mike, 2018. "Monetary policy normalisation and mortgage arrears in a recovering economy: The case of the Irish residential market," Papers WP613, Economic and Social Research Institute (ESRI).
    3. repec:esr:qecsas:2018:spring:fahy is not listed on IDEAS
    4. repec:esr:forcas:qec20191 is not listed on IDEAS
    5. Cumming, Fergus, 2018. "Mortgages, cash-flow shocks and local employment," Bank of England working papers 773, Bank of England.
    6. McCann, Fergal, 2017. "Resolving a Non-Performing Loan crisis: The ongoing case of the Irish mortgage market," Research Technical Papers 10/RT/17, Central Bank of Ireland.
    7. Kelly, Jane & Myers, Samantha, 2019. "Fixed-rate mortgages: building resilience or generating risk?," Financial Stability Notes 5/FS/19, Central Bank of Ireland.

    More about this item

    Keywords

    Monetary Policy; Mortgage Default;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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