DP16634 Breaking the Commitment Device: The Effect of Home Equity Withdrawal on Consumption, Saving, and Welfare
Author(s): | Agnes Kovacs, Patrick Moran |
Publication Date: | October 2021 |
Date Revised: | March 2022 |
Keyword(s): | commitment, Euler Equation, Household consumption, Mortgage Design |
JEL(s): | D15, E21, E71, G28, G51 |
Programme Areas: | Public Economics |
Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=16634 |
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.