Nominal interest rates have real effects. Residential mortgages and other real world debt contracts require a sequence of constant nominal payments. Combined with payment-to-income constraints, these nominal payments force borrowers to take on less debt when nominal interest rates rise, regardless of the behavior of the real interest rate. Survey data shows that conditional on the real rate, higher nominal mortgage interest rates reduce home buying sentiment. And increases in nominal mortgage rates reduce mortgage origination more in cities where payment to-income constraints are more likely to bind. We explore the macroeconomic implications of payment-to-income constraints in a new Keynesian model modified to include a credit good. The payment-to-income constraint amplifies the effect of current short-term nominal interest rates on output and inflation, making the model less forward-looking than the standard new Keynesian model.
Suggested citation:
Hausman, Joshua K., John V. Leahy, John Mondragon, and Johannes F. Wieland. 2026. “Real Effects of Nominal Interest Rates.” Federal Reserve Bank of San Francisco Working Paper 2026-07. https://doi.org/10.24148/wp2026-07