Academic Publications

2014
Daniel Cooper and Karen E. Dynan. 9/2014. “Wealth Effects and Macroeconomic Dynamics.” Journal of Economic Surveys, 30, 1, Pp. 34-55. Publisher's VersionAbstract

The effect of wealth on consumption is an issue of long-standing interest to economists.  Conventional wisdom suggests that fluctuations in household wealth have driven major swings in economic activity both in the United States and abroad. This paper considers the so-called consumption wealth effects. There is an extensive existing literature on wealth effects that has yielded some insights. For example, research has documented the relationship between aggregate household wealth and aggregate consumption over time, and a large number of household-level studies suggest that wealth effects are larger for households facing credit constraints. However, there are also many unresolved issues regarding the influence of household wealth on consumption. We review the most important of these issues and argue that there is a need for much more research in these areas as well as better data sources for conducting such analysis.

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2013
Karen E. Dynan and Wendy Edelberg. 9/2013. “The Relationship Between Leverage and Household Spending Behavior: Evidence from the 2007-2009 Survey of Consumer Finances.” Federal Reserve Bank of St. Louis Review , 95, 5, Pp. 425-48. Publisher's VersionAbstract
Some recent studies suggest that high levels of household debt and leverage have contributed to the relatively sluggish growth of consumer spending in the past few years (Dynan, 2012; Mian, Rao, and Sufi, 2013). However, this conclusion has not been widely accepted because of the empirical challenges associated with identifying the relationship amid the dramatic and complicated changes in the household economic environment during the Great Recession and subsequent slow recovery. Leverage may indirectly influence spending by increasing borrowing constraints, impeding refinancing, and raising the likelihood that a household will face future borrowing constraints. Leverage may directly influence spending simply by making some households uncomfortable with their leverage compared with some behavioral benchmark. The authors use the 2007-09 Survey of Consumer Finances panel to explore these issues. They find that highly leveraged households were more likely to report cutting back their spending in 2009, even after controlling for other factors expected to influence spending, such as changes in income and wealth. In analyzing that relationship, the authors find evidence that leverage influenced household spending through several channels. (JEL E21, E44, E51)
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2012
Karen E. Dynan, Douglas W. Elmendorf, and Daniel E. Sichel. 12/2012. “The Evolution of Household Income Volatility.” The B.E. Journal of Economic Analysis & Policy: Advances, 12, 2. Publisher's VersionAbstract

Using a representative longitudinal survey of U.S. households, we find that household income became noticeably more volatile between the early 1970s and the late 2000s despite the moderation seen in aggregate economic activity during this period. We estimate that the standard deviation of percent changes in household income rose about 30 percent between 1971 and 2008. This widening in the distribution of percent changes was concentrated in the tails. The share of households experiencing a 50 percent plunge in income over a two-year period climbed from about 7 percent in the early 1970s to more than 12 percent in the early 2000s before retreating to 10 percent in the run-up to the Great Recession. Households’ labor earnings and transfer payments have both become more volatile over time. As best we can tell, the rise in the volatility of men’s earnings appears to owe both to greater volatility in earnings per hour and in hours worked.

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Julia Coronado and Karen Dynan. 9/2012. “Changing Retirement Behavior in the Wake of the Financial Crisis.” Reshaping Retirement Security: Lessons from the Global Financial Crisis, Chapter 2. Publisher's VersionAbstract
The financial crisis and ensuing Great Recession left huge scars on household balance sheets, with households approaching retirement seeing the largest decline in wealth. This chapter examines how these households have adjusted to these developments. To date, most evidence on this question has come from surveys of household intentions. Using data on actual household behavior, we find that households nearing retirement are making up for financial losses by increasing saving and deferring retirement. They also appear to have reduced financial risk exposure by taking on less leverage and moving their portfolios in a more conservative direction.
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Karen E. Dynan. 6/2012. “Is a Household Debt Overhang Holding Back Consumption?” Brookings Papers on Economic Activity, Pp. 299-362. Publisher's VersionAbstract
The recent plunge in U.S. home prices left many households that had borrowed voraciously during the credit boom highly leveraged, with very high levels of debt relative to the value of their assets. Analysts often assert that this “debt overhang” created a need for household deleveraging that, in turn, has been depressing consumer spending and impeding the economic recovery. This paper uses household-level data to examine this hypothesis. I
find that highly leveraged homeowners had larger declines in spending between 2007 and 2009 than other homeowners, despite having smaller changes in net worth, suggesting that their leverage weighed on consumption above and beyond what would have been predicted by wealth effects alone. Results from regressions that control for wealth effects and other factors support the view that excessive leverage has contributed to the weakness in consumption. I also show that U.S. households, on the whole, have made limited progress in reducing leverage over the past few years. It may take many years for some households to reduce their leverage to precrisis norms. Thus, the effects of deleveraging may persist for some time to come.
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2011
Karen E. Dynan. 2011. “Comment on Inflation Dynamics and the Great Recession.” Brookings Papers on Economic Activity, Pp. 337-405. Publisher's VersionAbstract

This paper examines inflation dynamics in the United States since 1960, with a particular focus on the Great Recession. A puzzle emerges when Phillips curves estimated over 1960–2007 are used to predict inflation over 2008–10: inflation should have fallen by more than it did. We resolve this puzzle with two modifications of the Phillips curve, both suggested by theories of costly price adjustment: we measure core inflation with the weighted median of consumer price inflation rates across industries, and we allow the slope of the Phillips curve to change with the level and variance of inflation. We then examine the hypothesis of anchored inflation expectations. We find that expectations have been fully “shock-anchored” since the 1980s, while “level anchoring” has been gradual and partial, but significant. It is not clear whether expectations are sufficiently anchored to prevent deflation over the next few years. Finally, we show that the Great Recession provides fresh evidence against the New Keynesian Phillips curve with rational expectations.

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Karen E. Dynan and Ted Gayer. 2011. “The Government's Role in the Housing Finance System: Where Do We Go From Here?” The Future of Housing Finance. Publisher's VersionAbstract

It is time to commit to a future housing finance system for the United States as the current uncertainty surrounding this issue is likely deterring the recovery of the housing market and the broader economy. Returning to the system in place before the financial crisis is not a suitable option, as the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac created significant problems that contributed to the financial crisis. The GSEs’ pre-crisis activities also left the taxpayers with an enormous burden: As of early 2011, more than $100 billion had been put toward rescuing the GSEs and estimates suggest the total cost may be up to several times that when all is said and done.

In this paper, we discuss the weaknesses of the pre-crisis GSE model and lay out the broad outlines of a new housing finance model that attempts to address these problems. The new system includes a limited government role of providing credit guarantees for qualifying mortgage securities in normal times that becomes more expansive in times of mortgage market distress. It also attempts to reduce the incentives for excessive risk-taking embedded in the old system. This feature is essential to creating a stable and robust mortgage finance system, which, over the long run, can help foster economic growth.

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2010
Larry Cordell, Karen E. Dynan, Andreas Lehnert, Nellie Liang, and Eileen Mauskopf. 2010. “The Incentives of Mortgage Servicers and Designing Loan Modifications to Address the Mortgage Crisis.” Lessons from the Financial Crisis: Causes, Consequences, and Our Economic Future, Chapter 30. Publisher's Version
2009
Larry Cordell, Karen E. Dynan, Andreas Lehnert, Nellie Liang, and Eileen Mauskopf. 11/2009. “Designing Loan Modifications to Address the Mortgage Crisis and the Making Home Affordable Program.” Uniform Commercial Code Law Journal, 42.Abstract
Delinquencies on residential mortgages and home foreclosures have risen dramatically in the past couple of years. The mortgage losses triggered a broad-based financial crisis and severe recession, which, in turn, exacerbated the initial financial distress faced by homeowners. Although servicers increased their loss mitigation efforts as defaults began to mount, foreclosures continued to occur in cases where both the borrower and investor would be better off if such an outcome were avoided. The U.S. government has engaged in a number of initiatives to reduce such foreclosures. This paper examines the economic underpinnings of the Administration’s loan modification program, the Home Affordable Modification Program (HAMP). We argue that HAMP should help many borrowers avoid foreclosure, as its key features—a standardized protocol, incentive fees for servicers, and a requirement that the first lien mortgage payment be reduced to 31 percent of gross income—alleviate some of the previous obstacles to successful modifications. That said, HAMP is not well-suited to address payment problems associated with job loss because the required modification in such cases would often be too costly to qualify for the program. In addition, the focus of the program on reducing the payments associated with the mortgage rather than the principal of the mortgage may limit its effectiveness when the homeowner’s equity is sufficiently negative. In this case, recent government efforts to establish a protocol for short sales should be a useful tool in avoiding costly foreclosure.
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Karen E. Dynan, Wendy Edelberg, and Michael G. Palumbo. 5/2009. “The Effects of Population Aging on the Relationship among Aggregate Consumption, Saving and Income.” American Economic Review, 99, 2, Pp. 380-86. Publisher's VersionAbstract
As is well known, the US population has grown much older and is expected to continue to age. The share of adults age 65 or older—16 percent in 1980—has been rising steadily and is projected by the US Census Bureau to reach 22 percent by 2020. Given differences in saving rates and marginal propensities to consume (mpc’s) over the life cycle, demographic shifts could materially affect the relationship among macroeconomic aggregates such as income, consumption, and saving. A key question is how large these effects might be. Some past studies have used time series data to try to quantify these effects (for example, see Alan S. Blinder 1975), but demographics change more gradually than other determinants of aggregate spending, making it difficult to obtain precise estimates of the effects from such data. Our paper contributes to the literature by drawing lessons on how population aging might change the relationship between macroeconomic aggregates from household-level data. Household-level data enhance our ability to identify the effects because of the rich variation in consumption, saving, and income that we observe across households.
Karen Dynan. 2009. “Changing Household Financial Opportunities and Economic Security.” Journal of Economic Perspectives, 23, 4, Pp. 49-68. Publisher's VersionAbstract
Households have experienced an expansion of financial opportunities over the past several decades. Expanded financial opportunities, such as the democratization of credit and new lending approaches, can yield benefits in terms of household economic security. However, the financial crisis that began in 2007 has powerfully illustrated that expanded financial opportunities can also pose dangers for households. By increasing the scope for investment in risky assets, people may end up with larger swings in wealth than they had anticipated. Households may borrow too much and then face obligations that are unsustainable given their resources. To explore these issues, I examine household data on wealth, assets, and liabilities going back 25 years and, in some cases, 45 years. I argue that changes in household finances in the decades leading up to the mid-1990s -- including the gradual rise in indebtedness -- likely increased household well-being, on balance, and contributed to a decline in aggregate economic volatility. However, changes in finances since the mid-1990s -- in particular, a much sharper rate of increase in household debt -- appear to have been destabilizing for many individual households and ultimately for the economy as a whole. I consider how the lessons learned in the current crisis might change household financial opportunities and choices going forward.
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2007
Karen E. Dynan and Enrichetta Ravina. 5/2007. “Increasing Income Inequality, External Habits, and Self-Reported Happiness.” American Economic Review, 97, 2, Pp. 226-31. Publisher's VersionAbstract

A large literature has documented an increase in income equality in the United States over the past several decades (see, for example, David H. Autor, Lawrence F. Katz, and Melissa S. Kearney 2006). At the same time, real aggregate income has risen markedly, and most socioeconomic groups have experienced at least some rise in real purchasing power. Standard models of consumption, which typically assume that an individual’s utility is based only on her own consumption, would predict that these gains have led to higher levels of happiness for all groups, albeit with greater increases for some more than others. Economists have long recognized, however, that an individual’s utility may depend not only on the level of her own consumption but also on how that level compares with the consumption of others. If preferences are characterized by such “external habits,” then the observed widening of the income distribution may have implications for the happiness of different groups that go beyond those associated with the changes in their respective incomes.

This study combines data from two sources to document the evolution of reported levels of happiness for different socioeconomic groups over the past 25 years and to explore whether those levels have been affected by the changing relative position of these groups within the income distribution. We find that people’s happiness appears to depend positively on how well their group is doing relative to the average in their geographic area, even after controlling for the level of their own income. This result is consistent with evidence in earlier work by Erzo F. P. Luttmer (2005) and Ravina (2005). In addition, we find some evidence that the relationship is much stronger for people whose group has above-average income than for people whose group has below-average income. It would thus appear that relative concerns do not become an issue until a person has attained a certain place within the income distribution.

Karen E. Dynan and Donald L. Kohn. 2007. “The Rise in U.S. Household Indebtedness: Causes and Consequences.” The Structure and Resilience of the Financial System, Proceedings of a Conference, Reserve Bank of Australia, Sydney, Pp. 84-122. Publisher's VersionAbstract
The ratio of total household debt to aggregate personal income in the United States has risen from an average of 0.6 in the 1980s to an average of 1.0 so far this decade. In this paper we explore the causes and consequences of this dramatic increase. Demographic shifts, house price increases and fi nancial innovation all appear to have contributed to the rise. Households have become more exposed to shocks to asset prices through the greater leverage in their balance sheets, and more exposed to unexpected changes in income and interest rates because of higher debt payments relative to income. At the same time, an increase in access to credit and higher levels of assets should give households, on average, a greater ability to smooth through shocks. We conclude by discussing some of the risks associated with some households having become very highly indebted relative to their assets.
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2006
Karen E. Dynan, Douglas W. Elmendorf, and Daniel Sichel. 1/2006. “Can Financial Innovation Explain the Reduced Volatility of Economic Activity?” Journal of Monetary Economics, 53, 1, Pp. 123-50. Publisher's VersionAbstract
The stabilization of economic activity in the mid 1980s has received considerable attention. Research has focused primarily on the role played by milder economic shocks, improved inventory management, and better monetary policy. This paper explores another potential explanation: financial innovation. Examples of such innovation include developments in lending practices and loan markets that have enhanced the ability of households and firms to borrow and changes in government policy such as the demise of Regulation Q. We employ a variety of simple empirical techniques to identify links between the observed moderation in economic activity and the influence of financial innovation on consumer spending, housing investment, and business fixed investment. Our results suggest that financial innovation should be added to the list of likely contributors to the mid-1980s stabilization.
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2004
Karen E. Dynan, Jonathan Skinner, and Steve Zeldes. 4/2004. “Do the Rich Save More?” Journal of Political Economy, 112, 2, Pp. 397-444. Publisher's VersionAbstract
The question of whether higher–lifetime income households save a larger fraction of their income was the subject of much debate in the 1950s and 1960s, and while not resolved, it remains central to the evaluation of tax and macroeconomic policies. We resolve this long‐standing question using new empirical methods applied to the Panel Study of Income Dynamics, the Survey of Consumer Finances, and the Consumer Expenditure Survey. We find a strong positive relationship between saving rates and lifetime income and a weaker but still positive relationship between the marginal propensity to save and lifetime income. There is little support for theories that seek to explain these positive correlations by relying solely on time preference rates, nonhomothetic preferences, or variations in Social Security benefits. There is more support for models emphasizing uncertainty with respect to income and health expenses, bequest motives, and asset‐based means testing or behavioral factors causing minimal saving rates among low‐income households.
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2003
Karen E. Dynan, Kathleen Johnson, and Karen Pence. 10/2003. “Recent Changes to a Measure of U.S. Household Debt Service.” Federal Reserve Bulletin, 89, Pp. 417-26. Publisher's Version PDF
Karen E. Dynan, Christopher D. Carroll, and Spencer D. Krane. 8/2003. “Unemployment Risk and Precautionary Wealth: Evidence from Households' Balance Sheets.” Review of Economics and Statistics, 85, 3, Pp. 586-604. Publisher's VersionAbstract

This paper examines precautionary behavior by relating job-loss risk to household net worth. We use existing best practice and some new strategies to deal with some problematic issues inherent in this literature regarding proxying uncertainty, instrumentation, and incorporating theoretical restrictions. We do not find precautionary variation in the wealth holdings of households with low permanent income, but do find precautionary effects for moderate and higher-income households. When the dependent variable is total net worth, these findings are robust to several alternative specifications. But we do not find precautionary responses in subaggregates of wealth that exclude home equity.

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2002
Glenn Canner, Karen E. Dynan, and Wayne Passmore. 12/2002. “Mortgage Refinancing in 2001 and Early 2002.” Federal Reserve Bulletin, 88, Pp. 469-81. Publisher's Version PDF
Karen E. Dynan, Jonathan Skinner, and Stephen P. Zeldes. 5/2002. “The Importance of Bequests and Life-Cycle Saving in Capital Accumulation: A New Answer.” American Economic Review, 92, Pp. 274-279. Publisher's VersionAbstract
As the workhorse of consumption and saving research for the past four decades, the life-cycle model has proved flexible and useful for examining a variety of questions. In a classic paper, Albert Ando and Franco Modigliani (1963 p. 56) stated a key assumption of the basic model: “[t]he individual neither expects to receive nor desires to leave any inheritance.” Although the authors contended that the absence of a bequest motive was not critical to the heart of their results, the assumption set off a long-standing battle over the relative importance of different motives for saving. In an influential study, Laurence Kotlikoff and Laurence Summers (1981) estimated that a large fraction of the U.S. capital stock was attributable to intergenerational transfers. Modigliani and his collaborators vigorously disagreed and, based on their own empirical work, claimed that life-cycle saving was the primary source of capital accumulation (Modigliani, 1988). Subsequent work has failed to reach a consensus.1 Since this debate began, an important advance in the consumption literature has been the incorporation of uncertainty in life-cycle models (see e.g., R. Glenn Hubbard et al., 1995). We argue that allowing for uncertainty resolves the controversy over the importance of life-cycle and bequest saving by showing that these motives for saving are overlapping and cannot generally be distinguished. A dollar saved today simultaneously serves both a precautionary life-cycle function (guarding against future contingencies such as health shocks or other emergencies) and a bequest function because, in the likely event that the dollar is not absorbed by these contingencies, it will be available to bequeath to children or other worthy causes. Under this view, households have a bequest motive, but bequests are given (i.e., the motive is “operative”) in only some states of the world.2 Wealth is something like traveler’s checks: you take them along on vacation “just in case,” but odds are they will remain uncashed and available for sundry goods after the journey is complete. We first demonstrate the result using a simple model and then argue that this approach reconciles the apparent importance of bequests with households’ declared focus on life-cycle saving. Finally, we consider implications of our analysis.
Karen E. Dynan, Kathleen W. Johnson, and Samuel M. Slowinski. 1/2002. “Survey of Finance Companies, 2000.” Federal Reserve Bulletin, 88, Pp. 1-14. Publisher's VersionAbstract

Finance companies are important providers of credit to households and businesses. For households, they originate loans and leases to finance the purchase of consumer goods such as automobiles, furniture, and household appliances; they also extend personal cash loans and loans secured by junior liens on real estate, such as home equity loans. For businesses, they supply short- and intermediate-term credit (including leases) for such purposes as the purchase of equipment and motor vehicles and the financing of inventories.

With roughly $1 trillion in financial assets as of mid-2000, the finance company sector occupies an intermediate position among the sectors that typically lend to households and businesses: In terms of assets, it is more than twice as large as the credit union sector, about the same size as the thrift sector, but only about one-fifth as large as the commercial banking sector. The approximately 1,000 companies that make up the sector (down from about 1,200 in 1996) range in size from very small to very large and include the ''captive'' subsidiary finance companies of motor vehicle manufacturers. The companies tend to be diversified, with more than 90 percent of the sector's assets as of mid-2000 held by companies that did not concentrate in any one type of receivable. The larger firms are more likely to be diversified; of the small firms that specialize, most focus on short- and intermediate-term business receivables. The sector is quite concentrated, and has been for some time, with the twenty largest companies accounting for more than two-thirds of total receivables (see box "Industry Concentration'').

The Federal Reserve System has surveyed the assets and liabilities of finance companies at roughly five-year intervals since 1955. The surveys provide benchmarks for the System's monthly report on the outstanding accounts receivable of finance companies and provide a comprehensive update on these companies' sources of funds. This information in turn becomes an important input to the estimates of total consumer credit and the U.S. flow of funds accounts produced at the Federal Reserve Board. Summarized in this article are the results of the most recent survey, which collected finance company balance sheet information as of June 30, 2000. (Details on sampling procedures are given in appendix A, and complete balance sheet data are provided in table B.1.)

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