Accounting for the Changing Role of Family Income in Determining College Entry

Assessing the importance of borrowing constraints for college entry is key for education policy analysis in the U.S. economy. I present a computable dynamic general equilibrium model with overlapping generations and incomplete markets that allows me to measure the fraction of households constrained in their college entry decision. College education is financed by family transfers and public subsidies, where transfers are generated through altruism on part of the parents. Parents face a trade-off between making transfers to their children and own savings. Ceteris paribus, parents who expect lower future earnings transfer less and save more. Data from the 1986 Survey of Consumer Finances give support to this mechanism. I show that this trade-off leads to substantially higher estimates of the fraction of constrained households compared to the results in the empirical literature (18 instead of 8 percent). The model also predicts that an increment in parents' earnings uncertainty decreases their willingness to provide transfers. In combination with rising returns to education, which makes college going more attractive, this boosts the number of constrained youths and explains why family income has become more important for college access over the last decades in the U.S. economy.