Abstract
This paper develops a theoretical and empirical framework to assess the heterogeneous effects of mortgage rates on housing returns when accounting for the zero lower bound regime of the policy interest rate and local market supply and demand conditions. Based on an interacted panel VAR, estimated on a dataset comprising of 146 metropolitan statistical areas for a time period between January 1995 and December 2020, our empirical findings show that the response of housing returns to a mortgage rate shock is larger in magnitude when the federal funds rate is at its zero lower bound. Various supply and demand conditions, including housing permits, personal income, employment, and population, matter for the transmission of a mortgage rate shock to housing returns in local markets. A partial equilibrium model supports our empirical results.