1. Investment Charts Winter 2006 Economics 102 Mr. Smitka

5. Mortgage Rates (30-yr bonds) & Housing Investment Households normally need a downpayment to finance a house In addition they borrow Banks however won’t lend 100% A rule of thumb: 20% of gross income A rule of thumb: 80% of market value Let’s see what sort of house you can buy...

6. Mortgages and Housing Affordability $833 monthly max $4,167 20% of Gross $50,000 per year $70,331 14%$ 88,000 $17,583 $75,333 13%$ 94,000 $18,833 $81,015 12%$101,000 $20,254 $87,505 11%$109,000 $21,876 $94,959 10%$119,000 $23,740 $103,568 9%$129,000 $25,892 $113,569 8%$142,000 $28,392 $125,256 7%$157,000 $31,314 $138,992 6%$174,000 $34,748 $155,234 5%$194,000 $38,809 amt of loaninterest affordable required rate house downpayment

7. Interest rates & investment At 5% you can buy a nice house, once you’ve saved for the downpayment At 14% you may not be able to buy any house -- $70,000 homes may not exist Housing investment is a big enough share of the economy to matter

8. Impact: Short vs Long Rates Quantitative links (short long) Long rates affect housing starts Business investment responds to short (bank) and medium (bond) interest rates Exchange rates respond to international differences in short rates

9. Business investment Empirically, interest rate elasticity is low Keynes had a better story: animal spirits At times optimism prevails, indeed feeds upon itself Also accelerator: higher I boosts growth making additional I look more attractive Rose bowl effect If the home team makes it there, and then wins … or other imponderables that cannot be predicted in advance

10. Housing investment is central

11. Impact: Timing and Magnitude Housing starts are hit quickly by higher rates, but it takes months for on-going construction to slow. Business investment responds only as new budgets are implemented (6-12 months) and is much more sensitive to expectations than to interest rates. Exchange rates change, but trade flows shift only with a 1-2 year lag.

12. Net Effect Response to higher interest rates is uncertain both in magnitude and timing.