The impact of interest-rate subsidies on household long-term debt: Evidence from a large program.∗

The response of household borrowing to changes in the interest rate is a crucial parameter to understand whether or not monetary policy can promote household investment in housing, and what are the determinants of the consumption durables. We provide an estimate of this response by exploiting a reform in a large program in Portugal: “Credito BoniÞcado” (CB). The CB program was launched in 1986 and subsidized the interest rate payments associated to mortgage loans to eligible households in the lower part of the income distribution. A reform in the program in 1998 introduced a cap in the value of the house that could be bought using the CB program. Households not eligible for the program were not affected by the reform, and then provide a control group to evaluate the effects of the reform. We use this reform as a quasi-natural experiment to evaluate the effects of mortgage interest rate subsidies on household long-term debt. Our central estimates suggest that an increase in the interest rate of 2 points reduced the probability of signing a new loan by 4 percent. JEL codes: D12, D91, H20. ∗We would like to thank participants at seminars in the 2003 North American Summer Meetings of the Econometric Society, the second TMR network on the “Economics of Aging,” Universitat Pompeu Fabra, Universidade Nova de Lisboa, Università Roma II (Tor Vergata) and Banco de Portugal. We owe special thanks to Antonio Ciccone, Esther Dußo, Ed Glaeser, Sergi Jiménez, Adriana Kugler, Albert Marcet, Max Pinheiro, James P. Smith and Guglielmo Weber for their comments and suggestions. Pedro Próspero provided outstanding computing support. The research of Ernesto Villanueva was funded by the Spanish Ministry of Education. The analysis, opinions and Þndings of this paper represent the views of the authors, they are not necessarily those of the Banco de Portugal. †Banco de Portugal e Universidade Nova de Lisboa, Av. Almirante Reis, 71, 1150-012 Lisbon, Portugal. E-mail: [email protected] ‡Universitat Pompeu Fabra, Ramon Trias Fargas 25-27, 08005 Barcelona, SPAIN. Email: [email protected]