Discussion: “Temptation, Commitment, and Hand-to-Mouth Consumers” by Agnes Kovacs and Patrick Moran Fang Yao RBNZ

Summary Question: Answer: Empirical support: Why do a large fraction of US households hold so much illiquid assets (housing), but so little liquid assets? Answer: Housing serves as a saving commitment device, when households face temptations. households are tempted to consume their liquid assets, and therefore purchase housing as a saving commitment device. Empirical support: The fraction of wealth hand-to-mouth households Negative correlation between MPC and liquid assets Homeownership leads to greater wealth accumulation

Kaplan and Violante (2014) Question: Answer: Empirical support: Why do a large fraction of US households hold so much illiquid assets (housing), but so little liquid assets? Answer: Housing is illiquid, but offers a higher return than liquid assets (deposits). Households face tradeoffs between the utility gain from smoothing their consumption and high costs associated to adjusting illiquid assets, or foregoing high return by holding liquid assets. Empirical support: The existence of wealth hand-to-mouth households Negative correlation between MPC and liquid assets Homeownership leads to greater wealth accumulation Since two models achieve similar success in matching empirical observations. The question is which model has a more realistic assumption.

Key difference in assumption Kaplan and Violante (2014) Housing is illiquid, but offers a higher return than liquid assets (deposits). Kovacs and Moran (2017) Housing is illiquid, and generates lower return than liquid assets (stocks). Temptation in preference to make housing more attractive.

My Comment 1 The crucial assumption for the puzzle is: return of illiquid asset (housing) is lower than the return of liquid assets (stocks). I have three reasons to question this assumption: Historical data collected by Jorda, Schularick and Taylor show the opposite.

“The Rate of Return on Everything,1870–2015” by Jorda et al. (2017) Risk adjusted return: 2% (equity), 6% (housing)

My Comment 1 The crucial assumption for the puzzle is: return of illiquid asset (housing) is lower than the return of liquid assets (stocks). I have three reasons to question this assumption: Historical data collected by Jorda, Schularick and Taylor show the opposite. Low nation-wide return doesn’t mean no higher regional returns.

My Comment 1 The crucial assumption for the puzzle is: return of illiquid asset (housing) is lower than the return of liquid assets (stocks). I have three reasons to question this assumption: Historical data collected by Jorda, Schularick and Taylor show the opposite. Low nation-wide return doesn’t mean no higher regional returns. As housing is leveraged investment, return on equity (ROE) is much higher than return on assets (ROA). 𝑅𝑂𝐸= 𝐷 𝐸 𝑅𝑂𝐴− 𝑅 𝑚 +𝑅𝑂𝐴

My Comment 1 The crucial assumption for the puzzle is: return of illiquid asset (housing) is lower than the return of liquid assets (stocks). I have three reasons to question this assumption: Historical data collected by Jorda, Schularick and Taylor show the opposite. Low nation-wide return doesn’t mean no higher regional returns. As housing is leveraged investment, return on equity (ROE) is much higher than return on assets (ROA). 𝑅𝑂𝐸= 𝐷 𝐸 𝑅𝑂𝐴− 𝑅 𝑚 +𝑅𝑂𝐴 It is interesting to see what happens in the model with temptation, but housing offers higher return.

My Comment 2 I am wondering if housing is really so illiquid, given the existence of home equity loans. If temptation is the key driver, would the existence of home equity loans disqualifies housing as a saving comment device? Alternative saving commitment devices do exist, such as pension funds. Would modeling pension saving and pension income in life-cycle models also help to explain WHtM behavior? In KV, it is ok because even housing is not so illiquid, it still offers higher returns, so people will still hold housing.

No Pension Income

With Pension Income

Policy Implications Kaplan and Violante (2014) show that WHtM households respond strongly to temporary tax rebates, because they have high MPCs. Would that imply that the existence of WHtM households makes monetary policy more effective? My guess is no, because lower interest rates make mortgage cheaper and house prices higher. This will push up the return on housing. Would WHtM households spend more on housing, instead of consumption? In KV, it is ok because even housing is not so illiquid, it still offers higher returns, so people will still hold housing.