![Page 1: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/1.jpg)
Discussion of “Inflation Experiences and
Contract Choice – Evidence from Residential Mortgages”
by Matthew J. Botsch and Ulrike Malmendier
NBER SI 2015 Household Finance MeetingJuly 17 2015
Jonathan A. ParkerMIT Sloan finance
![Page 2: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/2.jpg)
1. The main idea
• Households who place greater subjective probability on the possibility of high inflation are more likely to choose fixed rate mortgages
• Would like to run binary-outcome regression:
or
• Note: πExperienced varies only by cohort and year• Potential problem: covariates (next slide)
![Page 3: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/3.jpg)
![Page 4: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/4.jpg)
![Page 5: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/5.jpg)
![Page 6: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/6.jpg)
2. The estimation methodology
Want to control for household characteristics that• are correlated with πExperienced • and drive mortgage choicePrime possibilities:• Wealth• Income• LTV• FICOOnly observe very few household characteristicsBut observe interest rate and characteristics of chosen mortgage
![Page 7: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/7.jpg)
Examples
• FICO varies with age and reflected in interest rate on mortgage options and so influence mortgage choice correlated with πExperienced
• Nonconforming varies with age and influence mortgage choices in a way correlated with πExperienced
• So . . .
![Page 8: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/8.jpg)
• Ideally, run the binary choice model based on
• But the rate is not observed for the unchosen option, so run a selection of FMR/ARM model to estimate the rates as a function of observables with the un-observables correlated with the error term in the rate equations. Selection equation:
• Construct FRM and ARM fitted rates & estimate
![Page 9: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/9.jpg)
1. WTP: 0.211/0.424 = 0.498 percentage points more for an FRM per 1% of higher πExperienced
- Odd identification of WTP for a macro person: the term structure represents the price of dollars today vs. dollars in the future, or different default risks and term structure of default risk, not different cost of mortgage
![Page 10: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/10.jpg)
2. What would happen if people did not pay attention to past inflation?• Paper: set =0 in utility of choice
equation (each containing ). Exaggerates effect.
• I would prefer:• πExperienced = US historical average π• Or post-Fed average π, or post-“LR PC is vertical”
average π, or post-ratex revolution average π• πExperienced = Advanced-economy historical average π• Market expectations from inflation swaps• Model-based forward-looking expectations (for a
country with massive debt and unfunded liabilities)
• “Partial-equilibrium” change
![Page 11: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/11.jpg)
3. Further comments/suggestions
1. Welfare: – Come up with a method & process for
inflation that implies optimal choices for households for whom the observed range of inflation expectations are not pivotal. Then calculate welfare. Will be much smaller.
– Or be agnostic about the correct choice• Federal credit subsidies are effectively larger for
FRMs
– Big (recent) debate over what the optimal contract is
![Page 12: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/12.jpg)
3. Further comments/suggestions
2. Corroborating evidence– Look at variance of inflation experience• You are looking at the choice of options
– Look at nominal interest rate experience• Why inflation not nominal interest rates?
– Look at house price experience• Lots of other experiences are correlated
with cohort and age – stock market, bond market, GDP growth• House prices have variation across
region/people
![Page 13: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/13.jpg)
3. Further comments/suggestions
3. Explicitly think about rejecting alternative theories– Inattention?– Optimism
![Page 14: Discussion of “Inflation Experiences and Contract Choice – Evidence from Residential Mortgages” by Matthew J. Botsch and Ulrike Malmendier NBER SI 2015](https://reader035.vdocument.in/reader035/viewer/2022062804/56649ed15503460f94bdf4c4/html5/thumbnails/14.jpg)
IV. Conclusion• This paper provides evidence that is
consistent with a body of work on the importance of experience for expectations, and inflation expectations in particular and then for these affecting real decisions – Not a smoking gun– But part of a growing body of evidence
• Higher past inflation experience leads to a higher WTP for bet that pays off when inflation high
• I am not sure yet whether this effect is big or small. Looks small to me.