Consumption and Savings Behaviour under Household Heterogeneity and Mortgage Debt

Since the GFC, mortgage debt and housing dynamics have been extensively researched. This issue is of central importance in understanding and analyzing individual consumption and savings behavior because housing takes up a large share in household illiquid assets, and most houses are financed with a mortgage loan. To realistically capture the evolution of mortgage debt in the household income and wealth distribution, it is necessary to take into account the issue of heterogeneity. Households differ in levels of wealth and equity, and thus differ in their decisions to consume and save. The implications of this type of heterogeneity has been proven to have effects on aggregate consumption and output. In this paper, I propose a model that incorporates i) heterogeneous households, ii) idiosyncratic labor income risk, and iii) incomplete markets. The model is set in a NK framework, enabling general equilibrium analysis. Furthermore, I utilize the finite difference method as an efficient method for solving for the general equilibrium. Some preliminary results indicate that under this setting, household consumption smoothing and precautionary savings motives still persist, and that the wealthy hand-to-mouth maintain a low level of consumption at all levels of mortgage indebtedness.