Rising indebtedness and hyperbolic discounting: a welfare analysis
AbstractIs the observed rapid increase in consumer debt over the last three decades good news for consumers? This paper quantitatively studies macroeconomic and welfare implications of relaxing borrowing constraints when consumers exhibit a hyperbolic discounting preference. In particular, the author constructs a calibrated general equilibrium life-cycle model with uninsured idiosyncratic earnings shocks and a quasi-hyperbolic discounting preference and examines the effect of relaxation of the borrowing constraint which generates increased indebtedness. The model can capture the two contrasting views associated with increased indebtedness: the positive view, which links increased indebtedness to financial sector development and better insurance, and the negative view, which associates increased indebtedness with consumers' over-borrowing. He finds that while there is a welfare gain as large as 0.4 percent of flow consumption from a relaxed borrowing constraint, which is consistent with the observed increase in aggregate debt between 1980 and 2000 in the model with standard exponential discounting consumers, there is a welfare loss of 0.2 percent in the model with hyperbolic discounting consumers. This result holds in spite of the observational similarity of the two models; the macroeconomic implications of a relaxed borrowing constraint are similar between the two models. Cross-sectionally, although consumers of high and low productivity gain and medium productivity consumers suffer due to a relaxed borrowing constraint in both models, the welfare gain of low-productivity consumers is substantially reduced (and becomes negative in the case of strong hyperbolic discounting) in the hyperbolic discounting model due to the welfare loss from over-borrowing. Finally, the author finds that the optimal (social welfare maximizing) borrowing limit is 15 percent of average income, which is substantially lower than both the optimal level implied by the exponential discounting model (37 percent) and the level of the U.S. economy in 2000 implied by the model (29 percent).
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 09-25.
Date of creation: 2009
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-10-31 (All new papers)
- NEP-DGE-2009-10-31 (Dynamic General Equilibrium)
- NEP-MIC-2009-10-31 (Microeconomics)
You can help add them by filling out this form.
Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:reading list or among the top items on IDEAS.Access and download statistics
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Diane Rosenberger).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.