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Human Capital Investment and Debt Constraints

  • David Andolfatto

    (Simon Fraser University)

  • Martin Gervais

    (University of Western Ontario)

When young individuals face binding debt constraints, their human capital investments will be insufficiently financed by private creditors. If generations overlap, then a well-designed fiscal policy may be able to improve human capital investments by replacing missing capital markets with an intergenerational transfer scheme. The optimal (balanced budget) fiscal policy in this context entails the joint provision of an education subsidy for the young and a pension program for the old, financed with a tax on those in their peak earning years. We demonstrate, however, that the desirability of such a cradle-to-grave policy depends crucially on the assumption of an exogenous debt constraint. If debt constraints arise endogenously for reasons of limited commitment, then the optimal (balanced budget) fiscal policy looks radically different. Furthermore, we find that cradle-to-grave type policy interventions may actually lead to lower levels of human capital investment as altered default incentives induce private creditors to contract the supply of student loans by an amount greater than the subsidy. In some cases, the constrained-optimal policy entails zero intervention. These results highlight the importance of taking seriously the reasons for why debt constraints exist. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2005.08.002
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 9 (2006)
Issue (Month): 1 (January)
Pages: 52-67

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Handle: RePEc:red:issued:v:9:y:2006:i:1:p:52-67
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  1. Michele Boldrin & Ana Montes, 2004. "The intergenerational state: education and pensions," Staff Report 336, Federal Reserve Bank of Minneapolis.
  2. Dirk Krueger & Fabrizio Perri, 1999. "Risk sharing: private insurance markets or redistributive taxes?," Staff Report 262, Federal Reserve Bank of Minneapolis.
  3. Timothy J. Kehoe & David K. Levine, 1992. "Debt constrained asset markets," Working Papers 445, Federal Reserve Bank of Minneapolis.
  4. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  5. 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.
  6. Stephen V. Cameron & James J. Heckman, 1998. "Life Cycle Schooling and Dynamic Selection Bias: Models and Evidence for Five Cohorts of American Males," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 262-333, April.
  7. Gropp, Reint & Scholz, John Karl & White, Michelle J, 1997. "Personal Bankruptcy and Credit Supply and Demand," The Quarterly Journal of Economics, MIT Press, vol. 112(1), pages 217-51, February.
  8. Kehoe, Timothy J & Levine, David K, 2001. "Liquidity Constrained Markets versus Debt Constrained Markets," Econometrica, Econometric Society, vol. 69(3), pages 575-98, May.
  9. Alex Monge & Lance Lochner, 2000. "Endogenous Credit Constraints And Human Capital Formation," Computing in Economics and Finance 2000 318, Society for Computational Economics.
  10. Card, David, 2001. "Estimating the Return to Schooling: Progress on Some Persistent Econometric Problems," Econometrica, Econometric Society, vol. 69(5), pages 1127-60, September.
  11. Stephen V. Cameron & James J. Heckman, 2001. "The Dynamics of Educational Attainment for Black, Hispanic, and White Males," Journal of Political Economy, University of Chicago Press, vol. 109(3), pages 455-499, June.
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