Mortgage spreads, asset prices, and business cycles in emerging countries

Abstract

We investigate an unexplored link between the US mortgage spread and business cycle and asset price fluctuations in emerging market economies (EMEs). Controlling for changes in global financial risk, an increase in the US mortgage spread leads to substantially lower EME output, investment, consumption, house and stock prices, and to a contraction in lending by global banks to EMEs. The explanatory power of US mortgage spread shocks for EME macroeconomic fluctuations increases with EME exposure to lending by global banks. This explanatory power is greatly reduced when we turn off the response of EME stock prices to movements in the US mortgage spread in a counterfactual experiment, demonstrating the channel through which US mortgage spread shocks are transmitted to EMEs. The US mortgage spread is a key driver of business and asset price cycles in EMEs when extending the baseline model with additional domestic and foreign variables, and considering alternative country subgroups.