The Fed, Monetary Policy and Your Mortgage Rate

This activity is appropriate for a principles macroeconomic course which covers the financial system and monetary policy. Prior to its implementation students would have already been introduced to the role of banks in the financial system, the Federal Reserve System and monetary policy. They should understand what an interest rate is and examples of different types of interest rates in the economy.

Before class, the instructor will assign the 10-minute podcast. It may be helpful for students to jot down some notes as they listen. The instructor could further structure the students' listening by providing some questions (see additional resources).

Overview

Students will listen to NPR's The Indicator podcast "How Mortgage Rates are Made" It features a conversation with a mortgage broker around the time when the Federal Reserve is poised to raise rates after a long time. The activity encourages students to think about how the Fed's action affects one of the most important individual financial decisions– homeownership.

Expected Student Learning Outcomes

After completion of this activity, students should be able to:

• Describe how the Federal Reserve's monetary policy actions are transmitted to mortgage borrowers
• Identify factors which influence the extent to which monetary policy will affect individual interest rates

Information Given to Students

The NPR  podcast "How Mortgage Rates Get Made" describes how the Fed's influence over the federal funds rate affects mortgages

Say you are considering taking out a mortgage to buy a home. Your mortgage broker (like Ms. Asher from the podcast) tells you that the Federal Reserve is expected to raise the federal funds rate by half a percentage point in the next few weeks.  What is your most likely reaction?

A. You expect your mortgage interest rate to go up by half a percentage point and budget accordingly

B You postpone your home buying decision because banks will be much less likely to lend now, and finding the right mortgage will be very difficult.

C. You become nervous that higher interest rates in the economy could lead to higher unemployment and so postpone your home buying decision

D. You dismiss this news because it will have no affect on your mortgage interest rate as you are a solid borrower with a strong credit score.

E. You do more research and discuss with your broker how the Fed's rate hike will affect your mortgage interest rate based on economic forecasts

Some notes on the available options for students:

Options A&B: While the correlation implied here is correct (mortgage rate will go up, banks will hold more reserves), the effect will not be as large as these answer imply

Option C: This choice shows that students understand the dual mandate which is great. But they should rationalize this answer by explaining that higher interest could increase layoff and whether all occupations/sectors will be equally affected.

Option D: This choice shows students recognize that mortgages depend on other criteria than just the federal funds rate but the wording is a bit strong.

Option E:  While this is the most correct reasoning, it is also open-ended so students should be encouraged to describe what conversation would they want to have with their mortgage broker or what are some other economic factors to consider given the situation

Q1) The Federal Funds rate is the:

1. interest rate banks pay when they borrow directly from the Fed.
2. overnight lending rate on loans from one major bank to another.(correct)
3. interest rate on short-term Treasury securities.
4. ratio of reserves to deposits

Q2) Fill in the two blanks: Consumer interest rates are typically ______ than and _______ correlated with the Federal Funds rates

1. Higher; negatively
2. Lower; negatively
3. Higher; positively (correct)
4. Lower; positively

Q3) Suppose the Fed has recently increased its target interest rate. Following this, you obtain a mortgage but observe that your mortgage rate is lower than the rate your friend got a few weeks earlier before the Fed raised rates. What could explain this difference

Students should mention factors like differences in risk profile of borrower and length of the mortgage (e.g. 15 year vs. 30 year). Also there may be differences in the banks that you and your friend borrowed from.