Financial Innovation, the Decline in Household Savings, and the Trade-off between Flexibility and Commitment

Agnes Kovacs and Patrick Moran

No 16634, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper investigates the trade-off between two opposing views of financial innovation: the benefit of improved flexibility and the potential cost of weakened commitment. To disentangle their relative importance, we estimate a model of household behavior that allows for the possibility that housing acts as a savings commitment device. Identification is achieved using novel evidence on consumption growth dynamics. We then use the estimated model to study the macroeconomic and welfare implications of giving households greater access to home equity. 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 decline in the personal saving rate. Welfare could be improved using alternative mortgage policies that better balance the trade-off between flexibility and commitment.

Keywords: Household consumption; Euler equation; Commitment; Mortgage design (search for similar items in EconPapers)
JEL-codes: D15 E21 E71 G28 G51 (search for similar items in EconPapers)
Date: 2022-03
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Citations: View citations in EconPapers (1)

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