10-Feb-23 Eurozone

When monetary policy gets complicated

Market participants appear to feel far more certain than the ECB itself that they already know what interest rates will be appropriate. We try to explain why.

Share of variable rate residential loans out of total new loan volumes for house purchases


Sources: ECB, Statistical Warehouse, DWS Investment GmbH as of 2/7/23

In recent years, few of today’s investors have spent much time in thinking through the monetary transmission dynamics during hiking, rather than loosening cycles. They might be overlooking that the Eurozone is still very heterogeneous, not least in terms of how monetary decisions impact different member states. Our Chart of the Week makes this point in one particularly important area where you might expect higher rates to slow economic activity. It shows the percentage share of adjustable-rate residential loans to households in the Eurozone as a whole, as well for its four largest economies. In Italy, that proportion (measured in terms of new residential loan volumes for house purchases) has risen sharply in recent months, hinting at the impact monetary normalization is likely to have in dampening construction there. To a lesser extent, that also appears to be the case in Germany.

Even among the big four, however, there are big divergences on just this one measure. Precisely why these differences – and even larger ones across all members - have persisted has been the subject of quite a few empirical studies in recent years, including by the ECB itself[1]">Fixed rate versus adjustable rate mortgages: evidence from euro area banks (europa.eu)]]. Alas, as one paper calling for more research laments, “our theoretical understanding of the significance of credit cycles is still very limited[2].” Or, as the psychologist Daniel Kahnemann, might have put it: “Our comforting conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance[3].”

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1. See, in particular, 2. Samarina, A., Zhang, L. and Bezemer, D., (2017), “Credit cycle coherence in the eurozone: Was there a euro effect?”, Journal of International Money and Finance. 77, p. 93, available at: Credit cycle coherence in the eurozone: Was there a euro effect? (rug.nl)

3. Kahneman, D. (2011), Thinking, Fast and Slow, Farrar, Straus and Giroux, p. 201

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