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Summary Beauty Truth about Housing Prices Truth about Ination and Business Cycles Conclusions Discussion of Garriga, Kydland and Sustek Mortgages and Monetary Policy Matteo Iacoviello Federal Reserve Board Fourth Wharton Conference on Liquidity and Financial Crises October 9, 2015 The views expressed in this paper are solely the responsibility of the author and should not be interpreted as reecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System.

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Page 1: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Discussion ofGarriga, Kydland and Sustek

�Mortgages and Monetary Policy�

Matteo IacovielloFederal Reserve Board

Fourth Wharton Conference on Liquidity and Financial CrisesOctober 9, 2015

The views expressed in this paper are solely the responsibility of the author and should not be interpreted as re�ecting the views of the Board of

Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System.

Page 2: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Summary of the Paper1. This paper studies monetary policy transmission in a housing modelwith prices that are �xed for 30 years

2. In certain circles, assuming nominal rigidities of this size is considered amajor crime

3. Interesting spin: the nominal rigidity here applies to mortgagepayments

4. Unlike price rigidity, this is a rigidity that is harder to question, andneeds no fairy to be justi�ed

Page 3: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Main Findings of the PaperMonetary policy characterized by shifts in the in�ation target.Two channels of monetary policy transmission:

1. Price channel (tilt/frontloading e¤ect): higher in�ation increasecurrent real payments relative to future real payments �> hurtsborrowers, even if it is neutral for investors

2. Wealth e¤ect channel: higher in�ation reduces current and expectedfuture real payments on outstanding mortgage debt and thus increasesdisposable income.

� ARM: high in�ation, higher interest rates, higher real payments (pricechannel dominates)

� FRM: high in�ation, lower real payments (wealth channel dominates)

Page 4: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Central Element of Transmission and Main FindingsResponses to 1 percentage point rise in in�ation

Page 5: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Central Element of Transmission and Main Findings� Monetary Policy Redistributes Wealth under Market Incompleteness(Figure 4 in the paper)

� ARM: High In�ation �> Higher Debt Payments on Impacts �>Borrowers�Wealth Drops �> Borrowers�Consumption Drops �>Borrowers�Hours Increase �> GDP up (relatively by a lot)

� FRM: High In�ation �> Lower Debt Payments on Impacts �>Borrowers�Wealth Increases �> Borrowers�Consumption mildly rises�> Borrowers�Hours slightly fall �> GDP down (relatively by little)

Page 6: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Discussion� My discussion will focus on two main issues

� (1) Beauty

� (2) Truth

Page 7: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Discussion� My discussion will focus on two main issues

� (1) Beauty

� (2) Truth

Page 8: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Discussion� My discussion will focus on two main issues

� (1) Beauty

� (2) Truth

Page 9: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Beauty� The channel and mechanisms by which surprises in in�ation redistributewealth is a classic.

A partial and incomplete list includes: Algan-Ragot, Auclert, Bernanke,Brunnermeier-Salnikov, Camera-Chien, Doepke-Schneider,Fischer-Modigliani, Fisher, Gornemann-Kuester-Nakajima,Meh-RiosRull-Terajima, myself, Sheedy, Sterk-Tenreyro, TobinGKS give proper and ample credit to many of them...

� What is new (and brilliant) in this paper is:� the illustration of the key channels� the quantitative application to one of the key markets whereunanticipated in�ation matters, both in the simple 2-period model andin the in�nite�horizon version

Page 10: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Beauty (continued)� The model is beautiful and perhaps true too, as it beautifully seems to�t moments

Page 11: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Beauty (continued)

Page 12: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Beauty (continued)

Page 13: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Truth� Can the channels in the model make sense of one speci�c business cycleevent in U.S. macroeconomic history?

� Can the channels in the model explain some conditional correlations,not just unconditional moments?

Page 14: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

In�ation and Housing Prices

Page 15: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Housing Prices in the Model� One would like to better understand how the model fares in thisdimension

� This is what a 1 ppt change in in�ation does in the model to housingprices

Page 16: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Housing Prices in the ModelOne would like to better understand how the model fares in this dimension

Page 17: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Page 18: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

In�ation and Business Cycles

Page 19: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Page 20: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

In�ation and Business Cycles in the ModelAround the early 1980s

� In�ation dropped from 10 to 2 percent in 5 years

� Output fell 6 percent below trend for 4 years� At the time, the prevalent debt instrument was the �xed-rate mortgage(ARMs did not take o¤ until after banks were allowed to provide themunder title VIII of the Garn-St. Germain Depository Institutions Act)

� According to the paper, disin�ation should have hurt substantiallyborrowers, bene�ted savers, made borrowers work more, led to a rise inoutput....

Page 21: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Page 22: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Volcker Disin�ation

Page 23: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Volcker Disin�ation

Page 24: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Volcker Disin�ation

Page 25: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

How In�ation a¤ects Borrowers (C) and Savers (C*)� In�ation bene�ts borrowers under FRM, hurts them under ARM� Model is an empirical success along this dimension (see e.g. in DiMaggio, Kermani and Ramcharan)

Page 26: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

However, for output to move, labor supply must move...� ...and it moves in counterintuitive ways in this model� those who are better o¤ after changes in the in�ation target, becomelazy, and work less

Page 27: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

The Volcker disin�ation under FRM� In�ation drops� Nominal mortgage payments do not adjust� Borrowers under FRM are worse o¤ o¤ and spend less

� As their wealth drops, they work more� Output may rise

Page 28: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Tension in the Model between Consumption E¤ects andLabor Supply E¤ects

� The Consumption E¤ects are right and sensible� The labor supply and output e¤ects are sort-of-strange

� One could get rid of wealth e¤ects with the appropriate preferences, butthen there would be no business cycles

Page 29: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

Tension in the Model between Consumption E¤ects andLabor Supply E¤ects

� At the macro level, the model might get some unconditionalcorrelations right

� But some micro correlations might be wrong� It is a beautiful mechanism, but perhaps needs a bit more to becomequantitatively important

� Could other forms of stickiness �x that?Let me bring in nominal rigidities

Page 30: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

In�ation Shocks without Nominal RigiditiesTarget shocks in Guerrieri and Iacoviello�s estimated housing model(all mortgages are short-term and ARM)

Impulse Responses to a persistent 1% rise in the central bank in�ation target.Other parameters as in Guerrieri-Iacoviello (2015), "Collateral Constraints andMacroeconomic Asymmetries"

Page 31: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

In�ation Shocks with Nominal RigiditiesTarget shocks in Guerrieri and Iacoviello�s estimated housing model(all mortgages are short-term and ARM)

Impulse Responses to a persistent 1% rise in the central bank in�ation target.Other parameters as in Guerrieri-Iacoviello (2015), "Collateral Constraints andMacroeconomic Asymmetries"

Page 32: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

SuggestionsThe Modeling of the FRM vs ARM is a gem: it should part of the toolkit ofevery macroeconomist working on housing and debt in quantitative models

Would like to have more tangible evidence that the model �ts the data

1. Can �xed-rate mortgages account for the delayed e¤ects of monetarypolicy shocks?

2. Is the current prevalence of FRM the reason why QE is not working?

3. Was the unusually high prevalence of ARM the reason why thetightening in 2005 produce a housing recession?

4. To what extent can 30 years of mortgage rigidities substitute for 1/2years price and wage rigidities in the standard textbook model? (say,after a 1% permanent rise in money supply)

Page 33: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

SuggestionsThe Modeling of the FRM vs ARM is a gem: it should part of the toolkit ofevery macroeconomist working on housing and debt in quantitative models

Would like to have more tangible evidence that the model �ts the data

1. Can �xed-rate mortgages account for the delayed e¤ects of monetarypolicy shocks?

2. Is the current prevalence of FRM the reason why QE is not working?

3. Was the unusually high prevalence of ARM the reason why thetightening in 2005 produce a housing recession?

4. To what extent can 30 years of mortgage rigidities substitute for 1/2years price and wage rigidities in the standard textbook model? (say,after a 1% permanent rise in money supply)

Page 34: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

SuggestionsThe Modeling of the FRM vs ARM is a gem: it should part of the toolkit ofevery macroeconomist working on housing and debt in quantitative models

Would like to have more tangible evidence that the model �ts the data

1. Can �xed-rate mortgages account for the delayed e¤ects of monetarypolicy shocks?

2. Is the current prevalence of FRM the reason why QE is not working?

3. Was the unusually high prevalence of ARM the reason why thetightening in 2005 produce a housing recession?

4. To what extent can 30 years of mortgage rigidities substitute for 1/2years price and wage rigidities in the standard textbook model? (say,after a 1% permanent rise in money supply)

Page 35: Discussion of Garriga, Kydland and Sustek … · Summary Beauty Truth about Housing Prices Truth about In⁄ation and Business Cycles Conclusions Discussion of Garriga, Kydland and

Summary Beauty Truth about Housing Prices Truth about In�ation and Business Cycles Conclusions

SuggestionsThe Modeling of the FRM vs ARM is a gem: it should part of the toolkit ofevery macroeconomist working on housing and debt in quantitative models

Would like to have more tangible evidence that the model �ts the data

1. Can �xed-rate mortgages account for the delayed e¤ects of monetarypolicy shocks?

2. Is the current prevalence of FRM the reason why QE is not working?

3. Was the unusually high prevalence of ARM the reason why thetightening in 2005 produce a housing recession?

4. To what extent can 30 years of mortgage rigidities substitute for 1/2years price and wage rigidities in the standard textbook model? (say,after a 1% permanent rise in money supply)