Working Paper: NBER ID: w25157
Authors: David W. Berger; Konstantin Milbradt; Fabrice Tourre; Joseph Vavra
Abstract: How much ability does the Fed have to stimulate the economy by cutting interest rates? We argue that the presence of substantial debt in fixed-rate, prepayable mortgages means that the ability to stimulate the economy by cutting interest rates depends not just on their current level but also on their previous path. Using a household model of mortgage prepayment matched to detailed loan-level evidence on the relationship between prepayment and rate incentives, we argue that recent interest rate paths will generate substantial headwinds for future monetary stimulus.
Keywords: Mortgage Prepayment; Monetary Policy; Interest Rates; Economic Activity
JEL Codes: E0; E2; E4; E43; E5; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| historical path of interest rates (E43) | current strength of monetary policy transmission channel through mortgage refinancing (E52) |
| rate cuts (E43) | refinancing (G51) |
| past Federal Reserve decisions (E52) | economy's sensitivity to current actions (F41) |
| long period of low rates (E43) | diminished effectiveness of monetary policy (E49) |
| frac 0 (Y20) | current stimulus power (L94) |
| secular decline in mortgage rates (G21) | increase in frac 0 (C69) |
| refinancing (G51) | significant purchases (e.g., cars) (G51) |