When mortgage rates do not move: implications for monetary policy transmission

This paper studies how regulated mortgage contracts and state-provided housing credit shape the transmission of monetary policy in emerging economies. To do so, we develop a HANK model with housing and long-term mortgages in which mortgage rates respond weakly to the policy rate, similarly as in Mexico and Brazil. We show that, in such an environment, monetary policy not only loses a significant part of its strength, but also that the extent of this weakening depends critically on the fiscal rule. Under a balanced-budget rule, in which the required fiscal adjustment occurs contemporaneously, monetary tightening still lowers inflation and consumption, although by less than in an economy where mortgage rates fully respond to the policy rate. Under a slow fiscal adjustment, where new public debt can be generated, however, the housing credit channel is largely shut down and monetary transmission may even reverse, with inflation rising rather than falling. Two mechanisms are central to this result. First, the cash-flow channel is weakened, since indebted households are insulated from changes in the policy rate when mortgage payments do not move, dampening the effect of monetary policy on their consumption. Second, state-provided housing mortgage credit creates an implicit subsidy when the government lends at mortgage rates that are disconnected from the policy rate while funding conditions remain sensitive to it. This interest-rate wedge generates fiscal pressures and induces a fiscal response that interacts with monetary policy and affects its transmission. We also show that mortgage-rate cuts used as a credit stimulus can support activity in the short run, but do not generate medium-term growth: over time, fiscal correction and the induced monetary response lead to lower output and significant redistributive effects, with low-wealth households and renters bearing most of the cost.