“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. This paper explores how monetary policy affects aggregate demand by influencing these portfolio choices. To quantify this channel, I build a heterogeneous-agent life-cycle model with long-term mortgages and endogenous house prices. I find that, although only a small fraction of households adjust their housing and mortgage holdings in response to an expansionary monetary policy shock, these households account for 50 percent of the increase in aggregate demand. Mortgage refinancing explains approximately two thirds of the contribution, whereas adjusted housing choices account for one third—uncovering a new transmission channel. I also show that the pass-through of the policy rate to mortgage interest rates significantly affects the response in house prices and aggregate demand. Moreover, the different pass-through to short and long mortgage rates drives the difference in the aggregate demand response between economies with predominantly adjustable-rate mortgages and economies with fixed-rate mortgages.
“Dominated pension investments: the role of search frictions and unawareness”
With Louise Lorentzon
The market for long-term savings in mutual funds is characterized by high price dispersion between similar funds. We conduct a large-scale field experiment in the Swedish pension system to examine to what extent information and search frictions can explain why savers choose high-fee index funds, i.e., dominated funds. Our results show that a lack of awareness and search costs account for approximately one third of dominated fund holdings. Information letters that increase awareness of a dominated choice and reduce search costs to find the dominating alternative improve many savers’ real investment choices and can be justified from a cost-benefit analysis.
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.