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Discussion Paper Details

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Title: Breaking the Commitment Device: The Effect of Home Equity Withdrawal on Consumption, Saving, and Welfare

Author(s): Agnes Kovacs and Patrick Moran

Publication Date: October 2021

Keyword(s): commitment, Euler Equation, Household consumption and Mortgage Design

Programme Area(s): Public Economics

Abstract: This paper investigates the macroeconomic and welfare implications of permitting home equity withdrawal. We evaluate the trade-off between two opposing views: the benefit of improved consumption smoothing and the potential cost of weakened commitment. To disentangle their relative importance, we estimate a life-cycle model containing both channels. 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 percentage point reduction in the personal saving rate. Welfare could be improved using state-contingent mortgages that better balance the trade-off between flexibility and commitment.

For full details and related downloads, please visit: https://cepr.org/active/publications/discussion_papers/dp.php?dpno=16634

Bibliographic Reference

Kovacs, A and Moran, P. 2021. 'Breaking the Commitment Device: The Effect of Home Equity Withdrawal on Consumption, Saving, and Welfare'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=16634