Alternative Mortgage Instruments, the Tilt Problem, and Consumer Welfare.

The main purpose of this paper is to provide such analyses, using a lifecycle model of consumer choice first developed by Tobin and Dolde and later applied to housing by Dolde. The household is assumed to choose the levels of housing and nonhousing goods so as to maximize the present value of utility over a fixed period. The constraints facing the household include an intertemporal budget constraint and a series of financial or liquidity constraints that depict the difficulties facing the household in borrowing in the mortgage market. Application of numerical methods allows calculation of the optimal household choices under a variety of assumptions about household income and wealth, the rate of inflation, and, most importantly, the mortgage instrument available to the consumer. In addition, various measures of the household's willingness to pay for AMIs are presented. It is worth emphasizing that the focus here is on consumer choice in a certain world; that is, lender behavior is taken as exogenously determined, and the consumer is assumed to know the future path of prices, income, and interest rates. The paper also addresses a related question: what is the effect of fully anticipated inflation on a consumer's housing decisions? Here the direction, as well as the magnitude of the impact, is uncertain. On a theoretical level, Ranney and Schwab find that an increase in the rate of anticipated inflation may have differing effects on the size of the house purchased, depending on the current mortgage market conditions, the financial constraints facing the household, and the level of inflation. In contrast, Wheaton demonstrates that inflation always increases housing demand, even in the presence of borrowing restrictions that require wealth to be nonnegative. However, he assumes that the household may continuously borrow against the capital gains on the house. On an empirical level, Hendershott and Rosen and Rosen suggest that an increase in inflation stimulates... [ABSTRACT FROM AUTHOR]