There has long been an interest in the impact of Federal Reserve communications and decisions on financial assets and the US economy in general, which has intensified with the Fed’s prominent role during the past financial crisis and the pandemic. Researchers have constructed shock series to examine how the Fed’s actions (Swanson 2021), and even the choice of words (Aruoba and Drechsel 2022), affect financial markets and the broader economy. They generally find that prices of financial assets tend to respond rapidly and significantly to the Fed’s monetary policy surprises.
Unlike the rapid response identified in the case of financial markets, house price growth has long been believed to be both smooth and relatively insensitive to changes in real or nominal interest rates (Case and Shiller 1989). Summarising the literature on this topic, Kuttner (2013) observes that while housing prices do adjust to monetary policy, the impact on prices only materialises after around two years.
In a recent working paper (Gorea et al. 2022), we use monetary policy shocks and a high-frequency measure of house prices to estimate the impact of changes in monetary policy on housing market activity. We find that house prices adjust in a matter of weeks instead of years, and changes are of a similar order of magnitude to the adjustment of financial assets to monetary policy surprises. This is because we use list prices to construct the high-frequency measure of house prices, which are more responsive to changes in economic conditions than transaction prices. In addition, our high-frequency approach that uses weekly variation in prices makes it easier to identify the response around monetary policy announcements, while more aggregated monthly data might hinder identification as other factors than monetary policy may be responsible for the month-to-month variation in prices.
Construction of house price indices
We use data on home listings and sales from the CoreLogic Multiple Listing Service Dataset. These data contain detailed information on the universe of all housing units, commercial properties, rentals, and land plots listed for sale or for rent on the Multiple Listing Service platforms in the US. Our cleaned data set consists of 92,064,327 listings for single-family homes and apartments from 2001–2019. From these listings we collect different characteristics of the property, such as the number of bedrooms and square feet of living space. Using hedonic regressions, we then construct a weekly list price index by zip code, controlling for property characteristics and seasonality. Similarly, we also construct sale price indices based on the closing price for homes that sold in our data. Figure 1 shows how our list price index compares to the sale price index for the most populous zip code in Los Angeles—zip code 90011, and how our sale price index compares to the frequently used Zillow Home Value Index.
Figure 1 List and sale price indices for Los Angeles
Estimating the effect of monetary surprises
We use Jordà (2005)’s local projections method to estimate the average effect of a monetary policy surprise on house prices following a Federal Open Markets Committee (FOMC) meeting held by the Fed. Our baseline measures of monetary policy surprises are based on the Swanson (2021) series of monetary policy shocks. Swanson’s three shock series reflect unanticipated changes in the Federal Funds Rate, the Federal Reserve’s forward guidance and its large-scale asset purchases.
We find that list prices are highly responsive to shocks to forward guidance and large-scale asset purchases, but are less sensitive to shocks to the Federal Funds Rate (Figure 2). In response to a contractionary one-standard-deviation shock to forward guidance and large-scale asset purchases, list prices fall by 20 and 30 basis points respectively within two to three weeks following a monetary policy announcement. The magnitude of these responses is comparable to asset price responses on the day of an FOMC announcement. The key difference, however, is that financial assets respond the most to surprises in the level of the Federal Funds Rate, whereas house prices react to surprises in future interest rates.
Figure 2 Responses of housing list prices to contractionary monetary policy surprises
In our paper, we show that the somewhat counterintuitive insensitivity of house prices to the surprise in the Fed Funds Rate reflects, in part, changes of house price dynamics over time. When we estimate this response separately for two sub-samples (2001–2008 and 2009–2019), we find that it is different across the two periods. After 2008, the response is negative and significant, in line with our results on surprises to forward guidance and large-scale asset purchases. By contrast, the response to the surprises in the Fed Funds Rate during the 2001-2008 period is not statistically different from zero. Such insensitivity of house prices to changes in monetary policy could be attributed to the 2001–2007 housing boom. Slack credit market conditions (Favilukis et al. 2017, Vojtech et al. 2018, Drechsler et al. 2022) and exuberant expectations of high house price growth (Kuchler et al. 2022) may have counteracted the effect of rising interest rates by the Fed during this time.
Mortgage rates and housing prices
In the working paper, we also explore a key channel through which monetary policy shocks affect house prices—mortgage rates. When mortgage rates increase, credit becomes less available, which cools housing demand, especially from financially constrained households. To test this hypothesis, we first examine how mortgage rates change in response to monetary policy shocks and then how house prices respond to unexpected changes in mortgage rates.
We use data on 30-year fixed-rate mortgages from the Primary Mortgage Market Survey and show that mortgage rates respond quickly and significantly to monetary policy surprises, in particular to shocks related to forward guidance and large-scale asset purchases (Figure 3). Mortgage rates rise by 2 and 4 basis points within two weeks in response to contractionary surprises in forward guidance and large-scale asset purchases, and within a month, both cause a roughly 4 basis point persistent increase in mortgage rates.
Figure 3 Responses of mortgage rates to contractionary monetary policy surprises
To obtain more direct evidence of the mechanism, we estimate the response of list prices to exogenous variation in mortgage rates using an instrumental-variable approach, which uses the Swanson (2021) factors as instruments for mortgage rates. Figure 4 shows that a 1 percentage point exogenous increase in the mortgage rate lowers list prices by around 3% within one month. Such a response implies a semi-elasticity of 3, at the lower end of the range of 3 to 8 in the literature.
Figure 4 Responses of list prices to an exogenous +1 percentage point change in mortgage rates
Monetary tightening has been mentioned as a possible contributor to recent declines in house prices.
However, the literature generally has held that housing prices take years to adjust to changes in monetary policy. We provide new evidence that suggests that house prices respond to monetary policy surprises much more quickly than previously thought, in a matter of weeks rather than years. We show that the key channel for a fast reaction in house prices is the near-immediate adjustment of mortgage rates following monetary policy surprises. Our results can provide a justification for the claim that recent declines in housing prices have been influenced by monetary tightening and subsequent mortgage rate increases.
Authors note: Any opinions expressed here are those of the authors and do not reflect those of the Federal Reserve Bank of San Francisco, the Federal Reserve System, the European Investment Bank, the Bank of Canada, or any other organization with which authors are affiliated.
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Vojtech, C M, B S Kay and J C Driscoll (2018), “The Real Consequences of Bank Mortgage Lending Standards”, SSRN.