Interest rate changes, mortgages and consumption: evidence from Italy

Using the Italian Survey of Household Income and Wealth (SHIW), we study whether the drop in interest rates following the Great Recession was associated with an increase in consumption for households with Adjustable Rate Mortgages (ARM) relative to those with Fixed Rate Mortgages (FRM). After the reduction in mortgage payments, consumption of ARM holders increases relative to FRM but the implied marginal propensity to consume (MPC) is not statistically different from zero. We suggest three explanations for the weak consumption response to the income shock. First, cash-on-hand and debt heterogeneity may attenuate the consumption response. Second, borrowers believe that the income shock was short-lasting, and that interest rates would likely increase in the future, implying a small effect on consumption. Third, the shock is offset partly by a reduction in income from financial assets owned by mortgagors. The findings have implications for the conduct of monetary policy interventions and the credibility of the future path of interest rates, pass-through of monetary policy, and design of the mortgage market.