MORTGAGE LOAN RATES AND DEPOSIT COSTS - ARE THEY RELIABLY LINKED

The deposit-cost markup theory of Jaffe and Rosen's type suggests that the cost of attracting funds determines prices (mortgage loan rates). Other equally plausible theories argue for the reverse chain of event s, whereby mortgage loan rates induce changes in the deposit interest rates. We investigate these alternative hypotheses over the monthly pe riod 1970 to 1994 using causality and cointegration tests with allowan ces for possible structural breaks. The results from error-correction models indicate the presence of bidirectional causality between the mo rtgage loan rates and the deposit interest rates. The results further show that the two variables exhibit a strong cointegrating relationshi p and that several factors play an important role in determining both variables. Our findings underscore the need to continue with efforts t o develop and test multivariate error-correction models for the joint determination of the mortgage loan rate and the deposit interest rate.