Helping the Middle-Class: How Interest Rates Affect the Distribution of Housing Wealth

57 Pages Posted: 8 Nov 2015 Last revised: 2 Jun 2016

See all articles by Isaac Hacamo

Isaac Hacamo

Indiana University - Kelley School of Business - Department of Finance

Date Written: May 21, 2016

Abstract

This paper shows that declines in interest rates cause middle-priced neighborhoods to experience large increases in house prices, while high- and low-priced neighborhoods experience no changes. These effects are linked to a transmission channel that stems from the dependence of mortgage payments to interest rates. I introduce a novel identification strategy that exploits incidental differences in the distribution of the metropolitan population to estimate a measure of latent demand for small neighborhoods. A decline in mortgage interest rates of 1.2 percentage points from July 2000 to December 2001 leads to an average increase of 7% to 8.5% in house prices for middle-priced neighborhoods. The absence of an effect in high-priced neighborhoods is likely associated with the low marginal utility of housing consumption of high-income households; while the lack of an effect in low-priced neighborhoods is likely linked to credit-constrained low-income households. Lastly, a back of the envelope estimation suggests that 15% to 20% of the variation in house price growth during the 2000s housing boom may have been caused by the reduction in interest rates between July 2000 and December 2001.

Keywords: Interest rates, housing wealth, mortgage rates, house prices, housing demand, cost ofcapital, monetary policy

JEL Classification: E52, D14, D31, E21, R21, R31

Suggested Citation

Hacamo, Isaac, Helping the Middle-Class: How Interest Rates Affect the Distribution of Housing Wealth (May 21, 2016). Available at SSRN: https://ssrn.com/abstract=2687277 or http://dx.doi.org/10.2139/ssrn.2687277

Isaac Hacamo (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-7842 (Phone)

HOME PAGE: http://hacamo.weebly.com/

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