Exploiting variation in the timing of resets of adjustable-rate mortgages (ARMs), we find that a sizable decline in mortgage payments (up to 50 percent) induces a significant increase in car purchases (up to 35 percent). This effect is attenuated by voluntary deleveraging. Borrowers with lower incomes and housing wealth have significantly higher marginal propensity to consume. Areas with a larger share of ARMs were more responsive to lower interest rates and saw a relative decline in defaults and an increase in house prices, car purchases, and employment. Household balance sheets and mortgage contract rigidity are important for monetary policy pass-through. (JEL D12, D14, E43, E52, G21, R31)There has been a long-standing debate among economists regarding the effects of interest rates on the real economy (e.g., Bernanke and Gertler 1995). During the Great Recession, the Federal Reserve substantially reduced the overnight lending rate target and made large purchases of mortgage-backed securities in an attempt to stimulate household spending and support the prices of assets such as houses. This paper exploits this setting to explore how changes in interest rates impact the real economy. It establishes the effects of lower mortgage rates on adjustable-rate * Di Maggio: Harvard Business School, Baker Library 265,
Credit record panel data from 1999–2010 indicates that the likelihood of home equity extraction (borrowing, on average, about $40,000 against one's home) peaked in 2003 when mortgage rates reached historic lows. We estimate a 27 percent rise in extraction in response to a 100 basis point rate decline, and that house price growth amplifies this relationship. Differential responses to interest rates and home price appreciation by borrower age and credit score provide new evidence of financial frictions. Finally, equity extractions are associated with higher default risk, consistent with the use of borrowed funds for consumption or illiquid investment. (JEL D14, E43, E52, G12, R31)
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