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Effects of monetary policy on household expectations: The role of homeownership

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How does the Federal Reserve’s communication influence household inflation expectations, and what does this reveal about the effectiveness of monetary policy on diverse economic agents?

Image courtesy of interviewee. December 10, 2024

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This video discusses the dual mandate of the Federal Reserve, which involves achieving price stability and maximum employment through interest rate policy. The Federal Reserve uses tools like forward guidance to communicate future interest rate expectations to influence public and market behavior regarding borrowing and spending.

Key findings suggest that expectations about inflation and labor market conditions are significantly influenced by mortgage rates, particularly for homeowners, who are more responsive to changes in interest rates compared to renters. Homeowners tend to lower their inflation expectations and labor market optimism when mortgage rates rise, while renters show less sensitivity.

The study highlights the importance of homeownership in understanding how households respond to monetary policy and indicates that tailored communication strategies could enhance the efficacy of monetary policies. It notes that economic inequalities may be exacerbated if renters, often lower-income households, are less responsive to these communications.

Future research directions include exploring responsiveness to monetary policy across other demographics, such as asset holdings and political affiliations, as household beliefs about the Federal Reserve's political leanings can also influence their expectations and responses.

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Here are five key points from the video about the Federal Reserve's monetary policy and its effects on household expectations:

1. **Dual Mandate and Interest Rates**: The Federal Reserve operates under a dual mandate to achieve price stability and maximum employment. They utilize interest rates as a primary policy tool, which makes it challenging to simultaneously meet both objectives due to the complexities of managing expectations and economic conditions.

2. **Importance of Forward Guidance**: The Federal Reserve employs forward guidance as a communication strategy to provide insight into future interest rate changes based on current economic assessments. This strategy helps manage market and public expectations regarding borrowing, spending, and investment decisions, potentially stimulating economic growth when rates are expected to remain low.

3. **Household Heterogeneity in Response**: The effectiveness of the Fed's communication varies significantly between homeowners and renters. Homeowners tend to respond more sensitively to changes in mortgage rates compared to renters, who show less adjustment in their expectations regarding inflation and the labor market conditions.

4. **Time Lag in Household Response**: It takes time for households to respond to changes in monetary policy signals, often several months. Homeowners are more likely to adjust their expectations and outlook based on fluctuations in mortgage rates, while renters may not respond to such signals as effectively.

5. **Policy Implications and Inequality**: The study suggests that monetary policy impacts different demographic groups unevenly, highlighting the need for tailored communication strategies to reach renters and potentially mitigate economic inequalities. Homeownership status profoundly affects how households form expectations in response to the Fed's policies, which could contribute to widening economic disparities if not addressed.

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Here are some key quotes extracted from the video you that encapsulate its main ideas:

1. **Dual Mandate of the Federal Reserve**:
"Federal Reserve has a dual mandate, achieving price stability and maximum employment at the same time."

2. **Interest Rates as Policy Tools**:
"They use this interest rate as their policy tool... it's a difficult job for them to achieve both goals at the same time."

3. **Forward Guidance Communication**:
"One important policy towards this forward guidance... is this communication tool that they use... to signal the market and the public about what the Fed expects to set interest rates in the future."

4. **Managing Expectations**:
"By providing those clear signals about their future actions, the Fed aims to manage expectations about not only interest rates."

5. **Impact on Borrowing and Spending**:
"By managing expectations of interest rates, it affects households and firms’ borrowing, spending, and investment decisions."

6. **Mixed Results on Household Expectations**:
"Most of the recent empirical studies have found kind of mixed results regarding how effective it is household expectations... especially during periods when inflation is low or stable."

7. **Effect of Mortgage Rates**:
"When there is an increase in the mortgage rate, homeowners tend to lower their inflation expectations and reduce their optimism about future labor market conditions."

8. **Heterogeneity based on Home Ownership**:
"Monetary policy has meaningful effects on household expectations, but these effects are heterogeneously distributed across different groups, and it's primarily driven by home ownership."

9. **Longer Response Time to Policy Changes**:
"We find that it typically takes households several months to respond to changes in interest rates."

10. **Importance of Mortgage Holding**:
"We show that homeowners... adjust their expectations and labor market outlook more sensitively in response to changes in mortgage rates rather than renters."

11. **Policy Implications**:
"We believe that policymakers shouldn’t ignore the uneven impact of monetary policy across different demographic groups."

12. **Addressing Economic Inequality**:
"Lower-income households may be less responsive to monetary policy, which could exacerbate economic inequalities."

13. **Exploring Other Dimensions**:
"It’s important to explore heterogeneities across other dimensions... we have a follow-up study that looks at stock holdings."

14. **Political Polarization Affecting Responsiveness**:
"A lot of households believe that the Fed has a political leaning... they respond to the Fed’s communication very differently."

These quotes summarize the key points about the role of the Federal Reserve, the effectiveness of monetary policy, the influence of home ownership on economic expectations, and the implications of these factors on economic inequality and policymaking.

X-TIMESTAMP-MAP=LOCAL:00:00:00.000,MPEGTS:90000

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Federal Reserve has a dual mandate,

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achieving price bilities

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and maximum, employment at the same time.

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So they uses this interest rate, as their policy tools.

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Um, so with one interest rate, it's a difficult job

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for them to achieve both goals at the same time.

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Um, however,

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interest rate has different maturities you can sell the

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current interest rates or the longer run interest rates.

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So what the Federal Reserve does one important policy

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towards this forward guidance,

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where is this communication tool that they use in order

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to provide information about the likely future directions

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of interest rates, the future directions

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of monetary policy.

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So it involves signaling the market

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and the public about what the Fed expects

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to set interest rate in the future based on its assessment

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about the current economic conditions

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and the forecast of the future.

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So by providing those clear signals about their future

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actions, the Fed aims

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to manage expectations about not only interest rates,

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but also other macroeconomic conditions.

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So by managing expectations of interest rates,

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it affects households and firms borrowing spending

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and investment decisions.

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So if you know that the Fed is aims

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to keep the interest rates low for a long period

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of time than business and households, they tend to borrow

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and spend more, which can stimulate economic growth.

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The household side, most

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of the recent empirical studies have found kind

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of mixed results regarding how, how effective it is

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for this, for work guidance on affecting

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household expectations.

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A lot of the households, they don't seem to fully grasp

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or respond to the fed's policy signals in terms

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of their inflation expectations, especially

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during periods when infl, when the interest rate is low

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or the inflation rate is kind of stable.

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Um, so how effective are those four work guidance on

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household expectations?

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So it turns out that it depends on whether the household

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owns this houses or not.

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So we find that homeowners, they tend to be more sensitive

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to changes in interest rates

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and for raw guidance communications.

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This is because mortgage rates

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directly affects household finances,

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so especially for the homeowners.

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So when there is an increase in the mortgage rate,

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homeowners tend to lower their inflation expectations

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and they're going to reduce their optimism about future

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labor market conditions, which is consistent

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with the intended consequences of monetary policy.

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However, renters on the other hand, they're less likely

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to adjust expectations in respond to such policy signals.

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We conclude that monetary policy have meaningful effects on

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household expectations, but these effects are

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Heterogeneously distributed across different groups,

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and it's primarily driven by home ownership.

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Or work is, positioned at the intersection

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of two strands of literature.

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One is on this effect of monetary policy,

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on household expectations,

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and the other is on this household heterogeneity in the

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monetary policy transmission.

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So the literature on expectation formation

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and effectiveness of monetary policy,

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on household expectations has grown extensively

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during the past few years.

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Um, studies, using like information provision

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or focusing on a very narrow window around the FOMC meetings

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find that the Federal Reserves communication usually have

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limited effect on household expectations.

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Um, suggesting that well,

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household does not really respond very quickly

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to monetary policy communications, unlike the fi

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what the financial market does.

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So our study, we take a very different approach.

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Instead of looking at a very narrow window,

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we look at a longer time series

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and we exploit the variations in the interest rate over

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the past 30 years.

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So we find that it actually takes longer for the household

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to respond to changes, in

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mandatory policy communication.

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So instead of having a instantaneous response, we find

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that it typically takes household several months to respond

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to this kind of policy changes.

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And this response is mostly coming, from their responses

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to changes, in information from the mortgage rate.

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So there is also the strand

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of literature on the household heterogeneity

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in monetary policy transmission.

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So in that literature, they all point out

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to the importance of household heterogeneity.

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And our study, confirms this, these findings,

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but we point out to a new infor transmission channel,

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which is exactly this, expectation channel.

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Um, our study is consistent with the literature in the sense

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that, well, the literature points

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to this importance of mortgage holding.

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And we also show

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that mortgage holding is the key heterogeneity,

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that gener, that, stimulates households,

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heterogeneous, responses.

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We show that homeowners they have,

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better knowledge about mortgage rates,

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they have better knowledge about inflation rates,

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they forecast other macro variables more accurately compared

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to those who doesn't own homes.

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So our Starlights facts show that, homeowners,

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they adjust their expectations

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and labor market outlook more sensitively in response

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to changes in mortgage rates rather than renters.

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And the sensitivity is mostly coming from this forward

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guidance communication, which

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directly influences the longer term interest rates, such

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as, mortgage rates.

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So in our analysis, we've used data from the Michigan Serve

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of Consumers run by the University of Michigan,

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and the serve of consumer expectations, which is

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by the Federal Reserve Bank of New York.

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So the Michigan Survey of Consumers,

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that's the longest running survey in the us

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on household expectations.

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So both the Michigan Survey

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and, the New York, feds,

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consumer expectation survey.

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They have a lot of rich information on household

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demographics and which includes,

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information on whether household own house,

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ho I mean household own house or not CES.

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They provide more detailed information on household

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mortgage holding status and,

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information about their mortgage rate perceptions

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and economic outlooks.

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So using both service, they allow us

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to examine whether household on houses

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or not have an impact

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on their perceptions about macro variables,

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including interest rates, inflation rates,

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and sometimes even mortgage rates.

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So in our analysis, we control for a rich set

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of demographic variables such as income education,

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what are correlated with the home ownership status,

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to make sure that

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what we identify is solely coming from this heterogeneity

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of owning houses or not,

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but not driven by whether they're highly educated

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or whether they have higher income or assets.

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Our key finding is that homeowners, they are more likely to,

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lower their future inflation expectations

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and labor market optimism when the mortgage rates are rising

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while renters,

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they don't change their expectations much in response

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to this mortgage rate change.

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And we find that,

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forward guidance has this very important role

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in driving this results.

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So Federal Reserve has several different tools in affecting

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the term structure of the entire interest rate.

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The short term interest rate doesn't really have a

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significant effect on household expectations.

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It's their communications about the longer run

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interest rates, which is, is co moves with mortgage rates.

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That part of the communication is the key in affecting

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household expectations.

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So that speaks to this very important channel,

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which is the mortgage holding channel,

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and more specifically this refinancing channel.

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So we find an a symmetric effect

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of changes in mortgage rates and household expectations.

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So in the us, most of households are locked in

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for this 15 or 30 year fixed rate mortgage payments.

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And when the Fed changes interest rate,

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they will have an opportunity to refinance their mortgage,

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but they only have an incentive to do

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so if the mortgage rate is lower so that they can lower,

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their monthly payments.

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So right now the fed just signal that they're going

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to lower their interest rates.

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So there are a lot of discussions about whether I should

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refinance or not.

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So consistent with this, we find

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that homeowners expectations are most sensitive

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during the periods when interest rate DEC decreases.

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So when there is a better opportunity to refinance

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and their expectation moves less when mortgage rates are

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increasing because their incentives

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to refinance, is less.

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We believe that our study have very important

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policy implications.

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We show that home ownership status is a crucial factor in

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understanding how household form expectations in

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response to monetary policy.

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Um, so in terms of policy design, we believe

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that the policy makers,

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they shouldn't take into account this uneven impact

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of monetary policy across different demographic groups.

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So for example,

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they could tailor their communication strategies

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to target renters more effectively so

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that this hopefully could enhance the overall efficacy

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of monetary policy so that,

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there's a more even distribution

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of this message being communicated

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to all different groups of households.

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And our study also speaks to, economic inequality.

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So our funding suggests that we are renters who are often

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tend to be lower income households.

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They may be less responsive to monetary policy,

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which could exacerbate economic inequalities in times when

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the Fed focuses on using this,

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policy communication as a tool.

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But the renters doesn't get this message,

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so it potentially hurts their

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financial situation even further.

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And in terms of future studies, it's important

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to explore heterogeneities across other dimensions in their

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responsiveness to monetary policy.

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Um, we find that homeowner is important.

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Home is one of the largest assets of households.

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Um, other asset holding also matters.

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We have a follow-up study that looks at stock holdings.

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So if households own stocks,

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then stock market responds very quickly

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to monetary policy communications.

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And when they have the stock in their asset,

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they have more incentive to pay attention

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to what's going on in the economy.

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And it turns out that stockholders,

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their expectations are more sensitive, to

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monetary policy changes or other macroeconomic

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conditions compared to those who doesn't have stocks.

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Another dimension of,

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that we we're exploring is this political polarization.

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So the US economy has becoming more

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and more polarized in terms of like their political beliefs.

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Um, these days. We have a study that looks at,

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how households view the Central Bank

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and their own political affiliation, whether they line up

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with each other or not, has, what's the, what's the,

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what's the consequence of this misalignment

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of their own belief about

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Political, affiliation

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and their belief about the Fed political affiliation will

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affect their, responsiveness to the Fed's communication.

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So Fed is supposed to be this independent agency

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not leaning towards either demo, the demographic,

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the Democrats or the Republicans.

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But, it turns out

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that households beliefs doesn't seem to be this way.

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A lot of the households does believe

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that the Fed has a political leaning

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and depending on where,

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they think the Fed is leaning towards, they respond

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to the fat communication very differently.

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And when there is a change in the precedent, this,

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their belief about the fat also changes

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and that significantly affects us their, their,

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their expectation formation in response

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to fat communications.

Navigating the Dual Mandate: Federal Reserve's Interest Rate Strategies

00:00:00 - Federal Reserve has a dual mandate, achieving price bilities and maximum, employment at the same time. So they uses this interest rate, as their policy tools. so with one interest rate, it's a difficult job for them to achieve both goals at the same time. however, interest rate has different maturities you can sell the current interest rates or the longer run interest rates. So what the Federal Reserve does one important policy towards this forward guidance, where is this communication tool that they use in order

00:00:39 - of interest rates, the future directions of monetary policy. So it involves signaling the market and the public about what the Fed expects to set interest rate in the future based on its assessment about the current economic conditions and the forecast of the future. So by providing those clear signals about their future actions, the Fed aims to manage expectations about not only interest rates,

00:01:08 - So by managing expectations of interest rates, it affects households and firms borrowing spending and investment decisions. So if you know that the Fed is aims to keep the interest rates low for a long period of time than business and households, they tend to borrow and spend more, which can stimulate economic growth. The household side, most of the recent empirical studies have found kind of mixed results regarding how, how effective it is

Impact of Home Ownership on Household Economic Expectations

00:01:39 - household expectations. A lot of the households, they don't seem to fully grasp or respond to the fed's policy signals in terms of their inflation expectations, especially during periods when infl, when the interest rate is low or the inflation rate is kind of stable. so how effective are those four work guidance on household expectations? So it turns out that it depends on whether the household owns this houses or not.

00:02:13 - to changes in interest rates and for raw guidance communications. This is because mortgage rates directly affects household finances, so especially for the homeowners. So when there is an increase in the mortgage rate, homeowners tend to lower their inflation expectations and they're going to reduce their optimism about future labor market conditions, which is consistent

00:02:46 - However, renters on the other hand, they're less likely to adjust expectations in respond to such policy signals. We conclude that monetary policy have meaningful effects on household expectations, but these effects are Heterogeneously distributed across different groups, and it's primarily driven by home ownership. Or work is, positioned at the intersection of two strands of literature. One is on this effect of monetary policy, on household expectations,

Delayed Household Response to Monetary Policy

00:03:17 - monetary policy transmission. So the literature on expectation formation and effectiveness of monetary policy, on household expectations has grown extensively during the past few years. studies, using like information provision or focusing on a very narrow window around the FOMC meetings find that the Federal Reserves communication usually have limited effect on household expectations.

00:03:48 - household does not really respond very quickly to monetary policy communications, unlike the fi what the financial market does. So our study, we take a very different approach. Instead of looking at a very narrow window, we look at a longer time series and we exploit the variations in the interest rate over the past 30 years. So we find that it actually takes longer for the household to respond to changes, in

00:04:18 - So instead of having a instantaneous response, we find that it typically takes household several months to respond to this kind of policy changes. And this response is mostly coming, from their responses to changes, in information from the mortgage rate. So there is also the strand of literature on the household heterogeneity in monetary policy transmission. So in that literature, they all point out to the importance of household heterogeneity.

Mortgage Holding and Household Expectations

00:04:53 - but we point out to a new infor transmission channel, which is exactly this, expectation channel. our study is consistent with the literature in the sense that, well, the literature points to this importance of mortgage holding. And we also show that mortgage holding is the key heterogeneity, that gener, that, stimulates households, heterogeneous, responses. We show that homeowners they have, better knowledge about mortgage rates,

00:05:23 - they forecast other macro variables more accurately compared to those who doesn't own homes. So our Starlights facts show that, homeowners, they adjust their expectations and labor market outlook more sensitively in response to changes in mortgage rates rather than renters. And the sensitivity is mostly coming from this forward guidance communication, which directly influences the longer term interest rates, such as, mortgage rates.

00:05:56 - of Consumers run by the University of Michigan, and the serve of consumer expectations, which is by the Federal Reserve Bank of New York. So the Michigan Survey of Consumers, that's the longest running survey in the us on household expectations. So both the Michigan Survey and, the New York, feds, consumer expectation survey. They have a lot of rich information on household

Impact of Home Ownership on Economic Perceptions

00:06:26 - information on whether household own house, ho I mean household own house or not CES. They provide more detailed information on household mortgage holding status and, information about their mortgage rate perceptions and economic outlooks. So using both service, they allow us to examine whether household on houses or not have an impact on their perceptions about macro variables,

00:06:57 - and sometimes even mortgage rates. So in our analysis, we control for a rich set of demographic variables such as income education, what are correlated with the home ownership status, to make sure that what we identify is solely coming from this heterogeneity of owning houses or not, but not driven by whether they're highly educated or whether they have higher income or assets. Our key finding is that homeowners, they are more likely to,

00:07:30 - and labor market optimism when the mortgage rates are rising while renters, they don't change their expectations much in response to this mortgage rate change. And we find that, forward guidance has this very important role in driving this results. So Federal Reserve has several different tools in affecting the term structure of the entire interest rate. The short term interest rate doesn't really have a

Impact of Interest Rates on Mortgage Expectations and Homeownership

00:08:01 - It's their communications about the longer run interest rates, which is, is co moves with mortgage rates. That part of the communication is the key in affecting household expectations. So that speaks to this very important channel, which is the mortgage holding channel, and more specifically this refinancing channel. So we find an a symmetric effect of changes in mortgage rates and household expectations. So in the us, most of households are locked in

00:08:37 - And when the Fed changes interest rate, they will have an opportunity to refinance their mortgage, but they only have an incentive to do so if the mortgage rate is lower so that they can lower, their monthly payments. So right now the fed just signal that they're going to lower their interest rates. So there are a lot of discussions about whether I should refinance or not. So consistent with this, we find that homeowners expectations are most sensitive

00:09:06 - So when there is a better opportunity to refinance and their expectation moves less when mortgage rates are increasing because their incentives to refinance, is less. We believe that our study have very important policy implications. We show that home ownership status is a crucial factor in understanding how household form expectations in response to monetary policy. so in terms of policy design, we believe

Tailoring Monetary Policy Communication to Address Economic Inequality

00:09:34 - they shouldn't take into account this uneven impact of monetary policy across different demographic groups. So for example, they could tailor their communication strategies to target renters more effectively so that this hopefully could enhance the overall efficacy of monetary policy so that, there's a more even distribution of this message being communicated to all different groups of households. And our study also speaks to, economic inequality.

00:10:09 - tend to be lower income households. They may be less responsive to monetary policy, which could exacerbate economic inequalities in times when the Fed focuses on using this, policy communication as a tool. But the renters doesn't get this message, so it potentially hurts their financial situation even further. And in terms of future studies, it's important to explore heterogeneities across other dimensions in their

00:10:39 - we find that homeowner is important. Home is one of the largest assets of households. other asset holding also matters. We have a follow-up study that looks at stock holdings. So if households own stocks, then stock market responds very quickly to monetary policy communications. And when they have the stock in their asset, they have more incentive to pay attention to what's going on in the economy. And it turns out that stockholders,

Political Polarization and Its Impact on Monetary Policy Perceptions

00:11:12 - monetary policy changes or other macroeconomic conditions compared to those who doesn't have stocks. Another dimension of, that we we're exploring is this political polarization. So the US economy has becoming more and more polarized in terms of like their political beliefs. these days. We have a study that looks at, how households view the Central Bank

00:11:43 - with each other or not, has, what's the, what's the, what's the consequence of this misalignment of their own belief about Political, affiliation and their belief about the Fed political affiliation will affect their, responsiveness to the Fed's communication. So Fed is supposed to be this independent agency not leaning towards either demo, the demographic,

00:12:14 - But, it turns out that households beliefs doesn't seem to be this way. A lot of the households does believe that the Fed has a political leaning and depending on where, they think the Fed is leaning towards, they respond to the fat communication very differently. And when there is a change in the precedent, this, their belief about the fat also changes and that significantly affects us their, their, their expectation formation in response