The Wilder View

ECB Rates Policy is Clogged in Key Periphery Markets

How the Euro area (EA) will grow, according to Mario Draghi:

The outlook for economic activity should be supported by foreign demand, the very low short-term interest rates in the euro area, and all the measures taken to foster the proper functioning of the euro area economy.

In this post, I address Draghi’s point that the ECB 1% refi rate will support economic activity through the lens of the mortgage market. Specifically, I find that the interest rate channel is clogged in the economies that are in most desperate need of lower rates: Spain, Portugal, and Italy.

Regarding ‘very low short-term interest rates’, what Draghi means is that the standard interest rate channel of monetary policy will stimulate domestic demand via increased spending by consumers and firms. If ECB policy is indeed passing through to retail credit (households and firms that borrow from banks to buy goods and services), then we should see evidence of this as falling interest rates to retail credit sectors, like those for consumer goods, home mortgage lending, loans for businesses, or even corporate credit rates to finance business investment.

In mortgage markets, the Euro area average borrowing rates are indeed falling. Banks started lowering mortgage borrowing rates, on average, in September 2011 in anticipation of ECB rate cuts that eventually occurred (again) in November 2011. Specifically, average Euro area mortgage rates are down roughly .25% since the local peak in August 2011.

But a closer look across mortgage markets shows a worrying trend for key periphery economies. The pass-through from ECB rate setting policy to mortgage borrowing costs is clogged in Spain, Portugal, and Italy, where mortgage rates have risen since the ECB cut the refi rate to 1%. Indeed, these are the economies that ‘need’ the stimulus to offset the fiscal consolidation.

Sure, mortgage rates are arguably low – but they’re not lower.

In Spain and Portugal, 91% and 99% of their respective new stock of mortgages sit on variable rate loans, so the pass through to the real economy should be rather quick IF mortgage rates declined (see Table below). True, Spain and Portugal are unlikely to experience any boom in real estate lending over the near term. However, had the ECB policy lowered mortgage rates, then disposable income would rise via lower monthly mortgage payments, thereby stimulating other sectors of the economy, all else equal.

In Italy, just 47% of the mortgage market is variable, so the immediate stimulus would be more muted compared to Spain and Portugal via disposable income. However, Italy didn’t experience a credit boom, so lending to firms and households could and should be warranted. But amid the fiscal consolidation and stressed debt markets, fewer borrowers are credit worthy AND mortgage rates have risen near 1% since EA mortgage rates peak on average in August 2011.

Core mortgage rates are falling, and this could create a positive stimulus for Spain, Portugal, and Italy down the road. But for now, the transmission mechanism, dropping the ECB refi rate to 1%, is not easing housing and mortgage financial conditions in those economies hit hardest by fiscal austerity.

Rebecca Wilder

Reference Table: reference for variable rate share of mortgage market

11 Responses to “ECB Rates Policy is Clogged in Key Periphery Markets”

barfApril 5th, 2012 at 12:36 am

okay. "so how are the sales figures"? does Europe even allow real estate sales to be made public? if so "how do i get a copy of the what's for sale in Europe" section of the newspaper like i do in say…the New York Times or Wall Street Journal?

Patrick_VBApril 5th, 2012 at 11:17 am

Hi Rebecca,
Mario Draghi is also talking about "measures taken to foster the proper functioning of the euro area economy", i.e. structural reforms, of which labour market reforms. This means such things as making it easier to lay off workers, reduce minimum wages, reduce replacement income, and limit unemployment benefits in time. These are all elements that are sure to weigh on a household's short run decisions to consume and invest. In the "long run", I do think that such measures can be positive for economic growth and employment, inasmuch as they are accompanied by the right social safety nets and re-training programmes. However, these latter do not seem to stand out prominently in proposed structural reform programmes… So even if the monetary policy transmission channel was working correctly, I would not expect any robust domestic demand growth over the coming years, due to household fears of job and income losses. I bet the euro area household saving rate will rise quite a bit over the next few years.

Rebecca WilderApril 5th, 2012 at 12:15 pm

Hello Patrick_VB!

The structural reform could be a boon to long-term economic growth, as you suggest. But my only question is will there be enough time? The problem is, that policy is still so geared toward fiscal consolidation – will there be enough demand to even utilize any supply side reform? Even the IMF suggests in its review of Portugal that targets may be missed in the event that automatic stabilizers become necessary (see the press release….

If the Germans reward reform economies by reducing the focus on fiscal consolidation and ease liquidity and allow for countercyclical policy to work, I think that Spain and Italy, for example, will have a fighting chance.

more to follow…

Rebecca WilderApril 5th, 2012 at 12:15 pm

In 2004 the IMF included a chapter on structural reform in the WEO. My general take of this research is that structural reform may or may not even be successful in raising potential growth (New Zealand vs UK). But furthermore, it could take a decade to see the benefits from reform (as in the case of New Zealand). Finally, this paper made it clear to me that Europe is attempting structural reform that is unprecedented in developed market history, both on the scale and scope of the reform across sectors.

Paper link:

I have my doubts that time will be given. Thus, over the near term, short-term policy is meaningful. In the face of clogged channels of monetary stimulus, Italy and Spain are left to suffer. Hopefully reform economies will be given time.


Patrick_VBApril 5th, 2012 at 12:27 pm

Thanks for the IMF links! The first one does not seem correct though. I probably read the structural reform chapter of the 2004 WEO at the time, but I'll go refresh my memory on what they wrote.

Patrick_VBApril 5th, 2012 at 12:47 pm

I agree with you that the expected positive outcome of "structural reform" on economic growth is very uncertain. In this regard, Ireland was long held up as the poster child of successful structural reform in the EU ( We now know how this success story turned out. However, given the trend decline in working-age population growth rates in the EU, and given the trend decline in labour productivity growth rates, I also think that reforms aiming to achieve greater efficiency and to promote R&D, investment and entrepreneurship are laudable. Do they necessarily have to come at the expense of Europe's social protection model, I would say no. Though immediate reforms are probably unavoidable in some EU countries, some others could mitigate the austerity effects through generally more supportive economic policies.

HrbApril 12th, 2012 at 12:23 am

How ironic that europe really need a structural reform, not just those reforms supply-siders have in mind.

Euro isn't working and should be either reformed or dismantled. We need a new way to fund budget deficits, one that does not depend on markets..

Patrick_VBApril 12th, 2012 at 11:59 am

"How ironic that europe really need a structural reform, not just those reforms supply-siders have in mind"
Hrb, I suppose you mean that the European Union is in need of reforming its institutional structures? I completely agree (and I suspect that just about every economist in Europe does too). But there is nothing ironic about this. Most countries could do with reforms to their institutions; remember the political deadlock in the US about the inane debt ceiling issue? And think about the political instability in Japan and its effects on the Japanese economy. Not to mention China's institutions… As for the euro, it is doing quite well, thank you!
Regarding the funding of budget deficits: Deficits are financed in the short run by issuing public debt. In the long run, they are paid down by taxation. The only issue here is that of debt sustainability, which is very much linked to market perceptions.

EricApril 5th, 2012 at 1:55 pm

Rebecca, excellent post. Many argue home prices will move lower in the US because they feel that mortgage rates will track the 10 year government bond yield (which will rise). How do you feel about that analysis? It looks like at some point (look at Greece) that mortgage rates just become their own entity.

rayashton618November 5th, 2012 at 8:46 pm

I'm pretty certain the numbers are more gigantic here in the US, what with the legislature not by any means doing whatever our mass mortgage rates and actually leaving it to the banks to intensify our lives even. Regardless in Australia, each penny is generally elucidated.

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