U.S. Monetary Policy Surprises and Mortgage Rates

Abstract

This article examines how the U.S. monetary policy surprises impact the mortgage rates in the nation and across five regions from 1990 to 2008. Regression analysis based on bootstrapping shows that surprises in the target federal funds rate (the target factor) have a significantly positive impact on the 1-year adjustable-rate mortgage (ARM) rate within the week of the Federal Open Market Committee announcements and the positive impact lasts up to 1 week after the announcements. Surprises in the future direction of the Federal Reserve monetary policy (the path factor) have significantly positive impacts on both the 1-year ARM rate and the 30-year fixed mortgage rates in the first week after the announcement. Furthermore, the responses of mortgage rates are asymmetric and affected by the size of monetary policy surprises, the stage of the business cycle and whether the monetary policy is tightening or loosening. There also exists heterogeneity in the mortgage rate pass-through process across regions and monetary policy surprises have differential impacts on the regional mortgage rates. The cross-region variations are mainly correlated with the regional housing market conditions, such as home vacancy and rental vacancy rates.The transmission mechanism of monetary policy has been an important topic with significant policy implications. The main channel for such transmission is the interest rate channel, in which the pass-through of the key policy rate to retail bank interest rates is a fundamental element. It is generally believed that changes in the policy rate and money market rates can be transmitted into the retail bank interest rate (e.g., deposit rate and loan rate), which can ultimately influence the opportunity costs of consumption and investment and hence the aggregate demand and output. Therefore, an efficient pass-through process is critical to the successful implementation of monetary policy.In this article, we investigate the mechanism of pass-through to a key retail interest rate, the mortgage rate. This issue has become particularly important *