Rising indebtedness and temptation: a welfare analysis
AbstractIs the observed large increase in consumer indebtedness since 1970 beneficial for U.S. consumers? This paper quantitatively investigates the macroeconomic and welfare implications of relaxing borrowing constraints using a model with preferences featuring temptation and self-control. The model can capture two contrasting views: the positive view, which links increased indebtedness to financial innovation and thus better consumption smoothing, and the negative view, which is associated with consumers' over-borrowing. The author finds that the latter is sizable: the calibrated model implies a social welfare loss equivalent to a 0.4 percent decrease in per-period consumption from the relaxed borrowing constraint consistent with the observed increase in indebtedness. The welfare implication is strikingly different from the standard model without temptation, which implies a welfare gain of 0.7 percent, even though the two models are observationally similar. Naturally, the optimal level of the borrowing limit is significantly tighter according to the temptation model, as a tighter borrowing limit helps consumers by preventing over-borrowing.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 11-39.
Date of creation: 2011
Date of revision:
Other versions of this item:
- Makoto Nakajima, 2012. "Rising indebtedness and temptation: A welfare analysis," Quantitative Economics, Econometric Society, vol. 3(2), pages 257-288, 07.
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Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:
- Rising indebtedness and temptation: a welfare analysis
by Christian Zimmermann in NEP-DGE blog on 2011-11-19 02:00:01
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