How Does Monetary Policy Pass‐Through Affect Mortgage Default? Evidence from the Irish Mortgage Market

• Published date: 01 October 2022
• Author: DAVID BYRNE,ROBERT KELLY,CONOR O'TOOLE
• Date: 01 October 2022
• DOI: http://doi.org/10.1111/jmcb.12892

DOI: 10.1111/jmcb.12892

DAVID BYRNE

ROBERT KELLY

CONOR O’TOOLE

How Does Monetary Policy Pass-Through Affect

Mortgage Default? Evidence from the Irish

Mortgage Market

This paper uses a quasi-natural experiment to identify the impact of inter-

est rates on mortgage default. Using loan-level panel data for Ireland, we

deal with selection bias by exploiting the variation between two adjustable-

rate mortgages offered in the 2000s. Welink interest rates to default directly

through borrower installments. Wend a strong, statistically signicant, im-

pact of interest rates on default; a 1% increase in installment is associated

with a 5.8% increase in the likelihood of default. Wealso nd evidence that

negative equity amplies the increase in default risk caused by higher inter-

est rates.

JEL codes E52, E58, G01, G21

Keywords: monetary policy, mortgage default

A     and a concentration in

property lending has called into question the health of bank balance sheets in many

OECD countries such as Spain, Ireland, and the United States. One potential relief is

the extensive monetary policy loosening undertaken by Central Banks in most major

economies since the onset of the global nancial crisis in 2007. The direct impact

of these accommodative measures is reduced bank funding costs but another impor-

tant channel is the potential impact on loan delinquency, particularly in the mortgage

market.

The views presented in this paper are those of the authors alone and do not represent the ofcial views

of the Central Bank of Ireland or the Eurosystem. Any remaining errors are our own.

D B is a Senior Economist at Monetary Policy Division, Central Bank of Ireland (E-mail:

david.byrne@centralbank.ie). R K is Head of Division at Macro-FinancialDivision, Central

Bank of Ireland (E-mail: robert.kelly@centralbank.ie). C O’T is an Associate Research Pro-

fessor at the Economic and Social Research Institute (E-mail: conor.otoole@esri.ie).

Received February 19, 2020; and accepted in revised form April 15, 2021.

Journal of Money, Credit and Banking, Vol. 54, No. 7 (October 2022)

© 2021 The Ohio State University.

2082 :MONEY,CREDIT AND BANKING

It is empirically challenging to test the link between mortgage distress and mon-

etary policy as it depends on both the structure and pass-through of a given mort-

gage market (Hancock and Passmore 2011). For example, quantifying the impact of

Federal Reserve monetary policy actions postcrisis is difcult as the nature of the

U.S. mortgage market, characterized by 30-year xed loans, suffers a severe selec-

tion bias. This arises as renancing is required to take advantage of the lower debt

servicing cost and policy rate changes are not automatically passed through to bor-

rowers. The ability to renance is limited to customers with no deterioration in credit

score and/or negative equity; arguably the individualswith most to gain from reduced

installments. Ideally, accurate assessment of this channel requires a market operating

with full pass-through of policy rate changes for a random selection of borrowers and

the remainder unaffected by the policy rates as a control group.

While no mortgage market will ever meet this criteria, the structure of the Irish

mortgage market provides a unique opportunity as two similarly priced variable rate

mortgage contracts were offered at the same time for a limited period and, since orig-

ination, have experienced very differentrate paths. In this paper, we exploit the quasi-

experimental variation between these twovariable rate contracts to identify the impact

of changes in interest rates on mortgage default. We use a panel of loan-level admin-

istrative data for Ireland and deal with selection bias that is inherent in identifying

the impact of interest rates by exploiting the variation between these two types of

adjustable rate. We map changes in interest rates to default by quantifying the direct

effect through changes in borrower installments.

Our paper is linked to the broad body of research considering the triggers of mort-

gage default. Given the role played by housing nance in the global crisis (Mian and

Su 2009, 2011), a number of papers have considered such triggers focusing on both

unemployment and house price declines (Gerardi et al. 2008, Haughwout, Peach,

and Tracy 2008, Jiang, Nelson, and Vytlacil 2013, 2014). In general, this research

nds a role for both equity and income channels. Elul et al. (2010) nd an impact

of both illiquidity and equity in driving default. Mayer, Pence, and Sherlund (2009)

assess loan performance for subprime borrowers in the U.S. following the 2007 crisis

and nd that housing equity played a considerable role in driving default. Foote et al.

(2008) also nd negativeequity to be a driving factor while Gyourko and Tracy (2014)

note the income channel, and its measurement, is important. Irish-specic studies in-

clude Kelly and O’Malley (2016) and Lydon and McCarthy (2013), who also iden-

tify equity and unemployment shocks in mortgage default models. Additionally, the

paper is linked to the very extensive literature of pass-through of policyrates to lend-

ing rates. Ciccarelli, Maddaloni, and Peydro (2014) show from 2000 to 2007 euro

area monetary policy pass-through is relatively homogenous across countries. Hris-

tov,Hülsewig, and Wollmershäuser (2014) document how this almost complete pass-

through pre-2007 became signicantly distorted in the period thereafter, hampering

the effectiveness of monetary policy. This distortion is typied by the divergence in

mortgage interest rates between the two groups of Irish mortgage holders.

However, none of the aforementioned studies identify the impact of interest rate

shocks on default. Given the very extensive loosening of monetary policy globally,