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Time inconsistency and endogenous borrowing constraints

Author

Listed:
  • Joydeep Bhattacharya
  • Monisankar Bishnu
  • Min Wang

Abstract

This paper studies the welfare of time-inconsistent, partially sophisticated agents living under two different regimes, one with complete, unfettered credit markets (CM) and the other with endogenous borrowing constraints (EBC) where the borrowing limits are set to make agents indifferent between defaulting and paying back their unsecured loans. The CM regime cannot deliver the first best because partially sophisticated agents would undo plans laid out by previous selves and borrow too much. Somewhat counterintuitively, in some cases, the EBC regime may deliver higher welfare than the CM regime. These results speak to the academic debate surrounding the creation and functioning of the CFPB (Consumer Financial Protection Bureau) in the U.S. and its implementation of the ability-to-repay rule on lenders after the 2007-8 crisis. Such institutions generate commitment publicly and may help time inconsistent agents economize on the costs of private commitment provision.

Suggested Citation

  • Joydeep Bhattacharya & Monisankar Bishnu & Min Wang, 2020. "Time inconsistency and endogenous borrowing constraints," CAMA Working Papers 2020-57, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    • Handle: RePEc:een:camaaa:2020-57
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    File URL: https://cama.crawford.anu.edu.au/sites/default/files/publication/cama_crawford_anu_edu_au/2020-06/57_2020_bhattacharya_bishnu_wang.pdf
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    Keywords

    endogenous borrowing constraints; overborrowing; financial protection;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E70 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - General
    • G40 - Financial Economics - - Behavioral Finance - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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