Discussion paper

DP16634 Breaking the Commitment Device: The Effect of Home Equity Withdrawal on Consumption, Saving, and Welfare

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.

£6.00
Citation

Kovacs, A and (eds) (2022), “DP16634 Breaking the Commitment Device: The Effect of Home Equity Withdrawal on Consumption, Saving, and Welfare”, CEPR Press Discussion Paper No. 16634. https://cepr.org/publications/dp16634