Incomes rise for mortgage holders as interest rates fall

The reduction in interest rates since 2016 has increased cash-in-hand for mortgage holders while also reducing income for those who do not have mortgages through lower deposit rates, a Reserve Bank paper shows.

As part of the Bank’s analysis of the distributional effects of monetary policy this research aims to explain part of the savings redistribution transmission channel.

To do so the paper considers a thought experiment where the population in 2016 suddenly finds itself facing the lower retail interest rates that were prevalent in 2020.

Retail interest rates were lower in 2020 than 2016 due to a combination of factors, including lower global interest rates, and cuts in the Official Cash Rate in 2019 and in March 2020 following the COVID-19 virus pandemic.

The change in cash-in-hand for households directly following the fall in interest rates, is termed the cash flow effect of lower interest rates. This captures the price effect of the savings channel, but does not include any change in saving or borrowing that may occur due to lower interest rates.

Applying these new interest rates, the cash-in-hand for mortgage holders is estimated to rise by an average of 1.0%, while those who do not have mortgages experience a 0.4% decline due to lower income from deposit savings.

Low-income mortgage holders are the largest beneficiaries of the reduction in mortgage interest rates, and middle-aged households also see notable benefits. However, older households (those aged 55 and above) tended to see a reduction of their income due to lower interest rates – as these households tend to have smaller mortgages and more significant deposit savings.

Quantifying the change in cash-in-hand for different types of households also provides insights into how much the economy responds to lower interest rates. Highly-indebted lower income households tend to be more willing to spend any income boost, and the reduction in interest rates has increased incomes for this group during this period. This suggests that lower interest rates may have stimulated the economy quite strongly.

This analysis is partial in nature – it does not provide the full picture on the distributional impacts of policy. We need to continue to build up to the bigger picture in order to truly understand the implications of monetary policy and the current low interest rate environment for the distribution of wealth and income.

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