As households spend more of their income making payments on loans they are more likely to get into arrears. This risk rises gradually at first, but above a certain point they enter a danger zone where the probability of arrears rises sharply. Knowing where this danger zone lies is really important because, if it comes a little earlier or a little later, that can make a big difference to the number of people who fall into it, although as this post shows, it is hard to identify this danger zone precisely. Nevertheless, understanding what leads households to get into financial difficulty is crucial for assessing how such difficulties might increase following rises in interest rates or unexpected falls in income.
Continue reading “The danger zone – when should we worry about how much households spend on their mortgages?”
Angus Foulis and Saleem Bahaj
The macroprudential toolkit available to policymakers across several central banks is new and largely untested. For example, in the UK, the Bank of England’s Financial Policy Committee (FPC) has, since the financial crisis, received powers to alter bank capital requirements and to place restrictions on the terms of household mortgages for macroprudential purposes. These policy tools have not been used systemically in the past, so their impact and the FPC’s reaction function remain unclear. Moreover, in contrast to monetary policy, where price stability can be judged against inflation, the objective of macroprudential policymakers – the stability of the financial system – is inherently unobservable. Thus macroprudential policymakers face a high degree of uncertainty over the impact and effectiveness of their tools and a target variable they cannot perfectly observe.
Continue reading “Uncertainty is no excuse for not using macroprudential tools”