Investment ChartsWinter 2006

Economics 102Mr. Smitka

Mortgage Rates (30-yr bonds) & Housing Investment

Households normally need a downpayment to finance a house

In addition they borrowBanks 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...

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 loan interest affordable required rate house downpayment

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

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

Business investment

Empirically, interest rate elasticity is lowKeynes had a better story: animal spirits

At times optimism prevails, indeed feeds upon itselfAlso accelerator: higher I boosts growth making

additional I look more attractiveRose bowl effect

If the home team makes it there, and then wins … or other imponderables that cannot be predicted in advance

Housing investment is centralInvestment (Growth, % per annum)

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

Residential (households) Equipment and software (corporate)

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.

Net Effect

Response to higher interest rates is

uncertain both

in magnitude

and

timing.