Macroeconomic effects of mortgage interest deduction

This paper develops a general equilibrium model featuring tax deductible mortgage interest. There are two main results: (i) a higher mortgage interest deduction leads to higher house prices, more levered households, and a higher rate of mortgage default; (ii) when mortgage risk is high the presence of mortgage interest deduction leads to more volatile responses of the main macro-variables to exogenous shocks (i.e. preference, productivity, and mortgage riskiness shocks). The empirical and theoretical evidence presented support the idea that mortgage interest deductibility may be a relevant factor in the occurrence of homeowner foreclosures.
 
Keywords: Mortgage interest deduction, house prices, mortgage default, DSGE.
JEL classifications: E32, E44.

Working paper no. 514.