The cost-of-living-crisis has been a major concern for households across the world. This column examines the impact of the crisis on household wealth across various demographic and income groups in six euro area countries, focusing on the role of households’ mortgage status. The findings indicate that working-age mortgage holders have experienced wealth gains despite higher interest payments, due to the reduction in the real value of their mortgage debt. The authors show that the relative gains recorded by mortgage-holders are a key factor in explaining differences in the effects of the crisis across demographic groups.
The cost-of-living-crisis has been a major concern for households across the world, as the inflationary shock has eroded the purchasing power of their income and wealth, challenging their ability to pay for goods and services. It is now widely documented that this crisis has affected households in a heterogeneous way, with variations in consumption patterns, income sources, and wealth composition leading to different impacts from inflation. Recent studies generally conclude that pension-age households have been particularly affected, as they have seen the real value of their accumulated wealth diminish (e.g. Ferreira et al. 2024, Pallotti et al. 2023). At the same time, concerns were raised about the negative effects of rising interest rates on households with large mortgage balances (who are typically working-age), especially in countries featuring a high share of adjustable-rate mortgages (e.g. Adrian 2023). However, reconciling the narrative that focuses on mortgage holders with the academic literature is difficult, because recent studies have neither explored how interest rate hikes affected households, nor considered households’ mortgage status when evaluating the impact of the cost-of-living crisis.
In a recent paper (Chafwehé et al. 2024), we address this important point. Our study extends the framework of Auclert (2019) and Cardoso et al. (2024) to estimate the immediate effects of the cost-of-living crisis in six euro area countries: France, Italy, Greece, Germany, Portugal, and Spain. We consider the consequences of inflation as well as of the monetary and fiscal policy responses. These policy responses constituted an integral part of the cost-of-living crisis period, as they explicitly tackled the inflationary shock and were key determinants of its impact on households’ wealth. Accounting for them allows us to compare the impact of the crisis across countries with common monetary policy but different fiscal policy stance, providing a view on how successful the national policy mixes have been and who they have benefited the most. To conduct our analysis, we use survey data, primarily from the Household Finance and Consumption Survey (HFCS), combined with microsimulation techniques.
To gauge the influence of higher interest rates on household wealth, we calculate the unhedged interest rate exposure (URE), a concept defined by Auclert (2019). The URE measures a household’s exposure to interest rate fluctuations, represented by the net balance of assets and liabilities that need to be reinvested (if positive) or refinanced (if negative) at current interest rates. On the fiscal side, our methodology includes an evaluation of measures designed to mitigate price increases – referred to as ‘price-side measures’ – and initiatives aimed at directly supporting household incomes (‘income-side measures’). We base our approach on the method outlined in Freier and Ricci (2023), which provides a comprehensive framework for analysing such fiscal interventions.
The heterogeneous impact of the cost-of-living crisis on different demographic groups
In our analysis, we comprehensively assess the direct effects of the cost-of-living-crisis on household wealth. These include the impact of inflation on net nominal assets (known as the Fisher effect), changes in the purchasing power of nominal incomes and pensions, and differences in effective inflation rates faced by households due to differences in consumption patterns. Furthermore, it includes the influence of fiscal measures and the consequences of rising interest rates, which are an integral part of the cost-of-living crisis period, as they were implemented to explicitly tackle the inflationary shock. Thus, our approach provides a full picture of the immediate outcomes of the crisis, excluding the secondary effects that would arise from behavioural changes and broader economic adjustments.
Our results, depicted in Figure 1, are for the euro area as a whole, as proxied by the six countries included in our study. We categorise households into 20 groups, based on their position in the income distribution (from the first to the tenth decile) and the age of the household head (younger or older than 65 years). The findings reinforce the notion that pension-age households have been the most adversely affected by the cost-of-living-crisis. However, when we factor in the monetary and fiscal policy responses, we observe that pension-age households, on average, experienced less impact than otherwise predicted. This is due to the mitigating effects of fiscal transfers and the benefits of higher interest rates for this demographic group. Despite these interventions, many households still face significant losses, primarily because of the diminished real value of their nominal assets and the reduced purchasing power of their (nominal) labour and pension incomes.
Figure 1 The impact of the cost-of-living crisis on euro area households
Notes: The figure shows for each income decile the monetary loss from inflation relative to disposable income through a revaluation of nominal assets (Fisher effect), nominal income and consumption, together with the effect resulting from fiscal and monetary responses. The figure shows the weighted average effects across the six selected countries. Households are categorised as in working age when below the age of 65.
Mortgage status and type: Dissecting the differences across age groups
What underlies the varying impact of the cost-of-living-crisis across different age groups? To shed light on this, we delve deeper into the data by segmenting the working-age population (individuals between the ages of 25 and 64) based on their mortgage-holding status. Our results, summarised in Figure 2, reveal two notable observations. First, there is a significant divergence in the effects of the crisis when comparing mortgage-holders to those without a mortgage: mortgage-holders have experienced substantial wealth gains as a result of the crisis. Although rising interest rates have on average increased their mortgage payments, the inflation-driven reduction in the real value of their outstanding mortgage debt – through what we refer to as the Fisher effect – has been even more substantial. Second, working-age individuals without a mortgage have faced losses comparable to those of pension-age households. This suggests that the relative gains seen by mortgage-holders are a key factor in explaining the disparity between the effects on working-age and pension-age groups as illustrated in Figure 1.
Figure 2 Impact of the cost-of-living-crisis by age and mortgage status
Notes: The figure shows for each income decile the monetary loss from inflation relative to disposable income through a revaluation of nominal assets (Fisher effect), nominal income and consumption, together with the effect resulting from fiscal and monetary responses. The figure shows the weighted average effects across the six selected countries. Households are categorised as in working age when below the age of 65 and as having mortgage debt when holding a positive amount of mortgage debt.
To examine in more detail the effects of inflation and interest rates on mortgage-holders, we differentiate between those with fixed-rate mortgages and those with adjustable-rate mortgages in Figure 3. As the names suggest, only adjustable-rate mortgages are directly impacted by rising interest rates. However, both types of mortgage-holders carry a sizeable nominal debt, which means that they both benefit from the Fisher effect, through which inflation reduces the real value of their mortgage debt. According to our results in Figure 3, households with adjustable-rate mortgages have seen the reduction in their debt’s real value outweigh the additional costs from increased interest payments. Overall, our analysis indicates that mortgage-holders have been the main beneficiaries of the crisis because of the large gains they made from the devaluation of the real value of their mortgage debt.
Figure 3 Impact of the cost-of-living-crisis by mortgage type
Notes: The figure shows for each income decile the monetary loss from inflation relative to disposable income through a revaluation of nominal assets (Fisher effect), nominal income and consumption, together with the effect resulting from fiscal and monetary responses. The figure shows the weighted average effects across the six selected countries. Households are categorised as having mortgage debt when holding a positive amount of mortgage debt.
Further considerations in assessing the effects of the crisis on mortgage holders
The evidence we have presented suggests that mortgage holders have been relatively better off compared to other population groups following the recent cost-of-living crisis. However, it is crucial to consider the following caveats.
First, our analysis operates under the assumption that interest rates, alongside inflation, will quickly return to their pre-shock levels. Should the normalisation of interest rates take more time than expected – potentially occurring if inflation remains slightly but persistently above target – adjustable-rate mortgage holders might be more affected than suggested in this column. Prolonged periods of higher interest payments could lead to net losses for these households in the future.
Second, it is important to note that our analysis, while assessing the impact of the crisis on household wealth, may overlook other factors influencing welfare. Although an increase in real wealth due to inflation can suggest long-term benefits for mortgage holders, this might hide short-term challenges. Specifically, some households could experience a strain on their liquid asset holdings, particularly if they have adjustable-rate mortgages with increasing interest payments. This effect could be even more pronounced for young homeowners, who are often described as ‘wealthy hand-to-mouth’ (Kaplan and Violante 2014) because their wealth is largely tied up in illiquid assets such as their homes. A reduction in real cash flows (through, for instance, a reduction in the real value of their labour income) can hinder these households’ ability to maintain steady consumption, potentially resulting in significant welfare losses.
Lastly, our results focus solely on the direct, immediate impact of the crisis, with the current mortgage status of individuals assumed to be fixed. Consequently, we do not account for the effects on prospective home buyers who may face higher interest rates for their new mortgages – whether fixed or variable rate – compared to what was previously anticipated before the crisis. Our static approach does not capture the dynamic changes that could influence the housing market and the financial decisions of future homeowners.
Source : VOXeu
