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Welfare implications of the transition to high household debt

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  • Campbell, Jeffrey R.
  • Hercowitz, Zvi

Abstract

Aggressive deregulation of the mortgage market in the early 1980s triggered innovations that greatly reduced indebted households' required home equity, and a borrowing surge followed. This paper uses a calibrated general equilibrium model of lending from the wealthy to the middle class to evaluate the welfare effects of this reform quantitatively. We find that the "indirect" effects of endogenous interest rate and other relative price changes dominate the "direct" effect of relaxing the constraint. The borrowing household's welfare falls even though the reform directly relaxes a constraint on its trade. The saving household's welfare rises substantially.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 56 (2009)
Issue (Month): 1 (January)
Pages: 1-16

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Handle: RePEc:eee:moneco:v:56:y:2009:i:1:p:1-16

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Web page: http://www.elsevier.com/locate/inca/505566

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Keywords: Financial deregulation Mortgage debt Interest rates;

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References

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  1. Becker, Robert A, 1980. "On the Long-Run Steady State in a Simple Dynamic Model of Equilibrium with Heterogeneous Households," The Quarterly Journal of Economics, MIT Press, vol. 95(2), pages 375-82, September.
  2. Richard K. Green & Susan M. Wachter, 2005. "The American Mortgage in Historical and International Context," Journal of Economic Perspectives, American Economic Association, vol. 19(4), pages 93-114, Fall.
  3. Krusell, P & Smith Jr, A-A, 1995. "Income and Wealth Heterogeneity in the Macroeconomic," RCER Working Papers 399, University of Rochester - Center for Economic Research (RCER).
  4. Jeffrey R. Campbell & Zvi Hercowitz, 2005. "The Role of Collateralized Household Debt in Macroeconomic Stabilization," NBER Working Papers 11330, National Bureau of Economic Research, Inc.
  5. Dirk Krueger & Fabrizio Perri, 2006. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory -super-1," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 163-193.
  6. Benjamin M. Friedman, 1992. "Learning From the Reagan Deficits," NBER Working Papers 4022, National Bureau of Economic Research, Inc.
  7. Friedman, Benjamin M, 1992. "Learning from the Reagan Deficits," American Economic Review, American Economic Association, vol. 82(2), pages 299-304, May.
  8. Ray C. Fair & John B. Taylor, 1980. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Cowles Foundation Discussion Papers 564, Cowles Foundation for Research in Economics, Yale University.
  9. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
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