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On borrowing limits and welfare

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  • Francesc Obiols-Homs
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    Abstract

    We study the effect of borrowing limits on welfare in several versions of exchange and production economies. There is a "quantity" effect of a larger borrowing limit which is beneficial for liquidity constrained agents, but essentially irrelevant otherwise. There is also a "price effect" which tends to increase the interest rate so that lenders are better off and borrowers are worse off. The combination of these effects produces that aggregate welfare in equilibrium (or ex ante welfare) displays an inverted U-shape as a function of the borrowing limit. In infinite horizon economies with incomplete markets we find a sizable "middle class" of not liquidity constrained but indebted agents that observes small gains, or even loses, after the borrowing limit is enlarged.

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    File URL: http://research.barcelonagse.eu/tmp/working_papers/401.pdf
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    Bibliographic Info

    Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 401.

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    Date of creation: Oct 2009
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    Handle: RePEc:bge:wpaper:401

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    Related research

    Keywords: Borrowing constraints; incomplete markets; welfare;

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    1. Julio Davila & Jay H. Hong & Per Krusell & José-Victor Rios Rull, 2005. "Constrained efficiency in the neoclassical growth model with uninsurable idiosyncratic shocks," Cahiers de la Maison des Sciences Economiques b05066, Université Panthéon-Sorbonne (Paris 1).
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    7. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
    8. Eva Carceles Poveda & Arpad Abraham, 2004. "Endogenous Trading Constraints with Incomplete Asset Markets," 2004 Meeting Papers 667, Society for Economic Dynamics.
    9. Athreya, Kartik B., 2002. "Welfare implications of the Bankruptcy Reform Act of 1999," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1567-1595, November.
    10. Eduardo L. Giménez, 2003. "Complete and incomplete markets with short-sale constraints," Economic Theory, Springer, vol. 21(1), pages 195-204, 01.
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