“Costly reversals of bad policies: the case of the mortgage interest deduction”
Review of Economic Dynamics 2021, Vol. 40: 85-107
With Markus Karlman and Kasper Kragh-Sørensen
This paper measures the welfare effects of removing the mortgage interest deduction under a variety of implementation scenarios. To this end, we build a life-cycle model with heterogeneous households calibrated to the U.S. economy, which features long-term mortgages and costly refinancing. In line with previous research, we find that most households would prefer to be born into an economy without the deductibility. However, when we incorporate transitional dynamics, less than forty percent of households are in favor of a reform and the average welfare effect is negative. This result holds under a number of removal designs.
“The effects of monetary policy through housing and mortgage choices on aggregate demand”
(Job Market Paper, Winner of the UniCredit Foundation Best Paper Award at VMACS CopenhagenMacro Days)
Housing and mortgage choices are among the largest financial decisions households make, and they substantially impact households’ liquidity. In this paper, I explore how monetary policy affects aggregate demand by influencing these choices. To quantify this portfolio channel of monetary policy, I build a heterogeneous-agent life-cycle model with housing and long-term mortgage contracts. I find that, in response to an expansionary monetary policy shock, 90 percent of the direct increase in aggregate demand is a result of households’ discrete reallocations of their housing and mortgage holdings. The direct demand response is largely driven by an improved consumption smoothing among constrained households, whose liquidity improves when they update their housing and mortgage choices. Both lower mortgage interest rates and endogenously higher house prices are essential for the portfolio adjustments, and ultimately the response in demand. I also find that the effectiveness of monetary policy is highly dependent on the flexibility of the mortgage market. When mortgages have adjustable interest rates, as opposed to fixed rates, house prices increase substantially more, and the aggregate response of consumption is more than six times as large.
“Inertia of dominated pension investments: evidence from an information intervention”
With Louise Lorentzon
The market for long-term savings in mutual funds is characterized by high price dispersion between similar funds. In this paper, we conduct an empirical investigation into possible causes of imperfect competition in this market. We discriminate between three main hypotheses on the demand side: a lack of awareness of price dispersion, search costs, and financial illiteracy. We run a large-scale field experiment in the Swedish public pension system. Information letters are sent to pension savers in two index funds, where there exists a cheaper fund with the same index strategy. We show that an information intervention that increases the awareness of a cheaper, dominating fund, at the same time as it reduces the search costs for finding such an alternative, can significantly improve households’ real investment allocations. Nonetheless, a majority of savers who are sent information about the name of the dominating fund do not switch funds. Thus, the high degree of inertia in pension investments remains even when search frictions for identifying dominating alternatives are eliminated.
In this paper, we investigate to what extent stricter mortgage lending standards affect households’ ability to smooth consumption. Using a heterogeneous-household model with incomplete markets, we find that a permanently lower loan-to-value (LTV) or payment-to-income (PTI) requirement only marginally affects the aggregate consumption response to a negative wealth shock. We show that even the distribution of marginal propensities to consume across households is remarkably insensitive to these permanent policies. In contrast, households’ consumption responses can be reduced if a temporary stricter LTV or PTI requirement is implemented prior to a negative wealth shock. However, strong assumptions need to be made for temporary policies to be welfare improving.