Working Paper: CEPR ID: DP16634
Authors: Agnes Kovacs; Patrick Moran
Abstract: This paper investigates the trade-off between two opposing views of financial innovation: the benefit of improved flexibility and the potential cost of weakened commitment. To disentangle their relative importance, we estimate a model of household behaviorthat allows for the possibility that housing acts as a savings commitment device. Identification is achieved using novel evidence on consumption growth dynamics. We then use the estimated model to study the macroeconomic and welfare implicationsof giving households greater access to home equity. We find that the welfare cost of weakened commitment is substantial: approximately 1.7 times larger than the benefit of improved consumption smoothing. Both channels contribute equally to a 2.5 percentagepoint decline in the personal saving rate. Welfare could be improved using alternative mortgage policies that better balance the trade-off between flexibility and commitment.
Keywords: household consumption; Euler equation; commitment; mortgage design
JEL Codes: D15; E21; E71; G28; G51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial innovation (O16) | welfare cost (D69) |
| access to home equity (G51) | personal saving rate (D14) |
| weakened commitment (J12) | long-term decline of household savings (D14) |
| improved self-insurance (G52) | long-term decline of household savings (D14) |
| alternative mortgage policies (G21) | welfare (I38) |