A tale of two commitments: equilibrium default and temptation
I construct the life-cycle model with equilibrium default and preferences featuring temptation and self-control. The model provides quantitatively similar answers to positive questions such as the causes of the observed rise in debt and bankruptcies and macroeconomic implications of the 2005 bankruptcy reform, as the standard model without temptation. However, the temptation model provides contrasting welfare implications, because of overborrowing when the borrowing constraint is relaxed. Specifically, the 2005 bankruptcy reform has an overall negative welfare effect, according to the temptation model, while the effect is positive in the no-temptation model. As for the optimal default punishment, welfare of the agents without temptation is maximized when defaulting results in severe punishment, which provides a strong commitment to repaying and thus a lower default premium. On the other hand, welfare of agents with temptation is maximized when weak punishment leads to a tight borrowing constraint, which provides a commitment against overborrowing.
|Date of creation:||11 Dec 2013|
|Date of revision:|
|Contact details of provider:|| Postal: 10 Independence Mall, Philadelphia, PA 19106-1574|
Web page: http://www.philadelphiafed.org/
More information through EDIRC
|Order Information:|| Web: http://www.phil.frb.org/econ/wps/index.html Email: |
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jonathan Heathcote, 2003.
"The Macroeconomic Implications of Rising Wage Inequality in the United States,"
gueconwpa~03-03-19, Georgetown University, Department of Economics.
- Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2010. "The Macroeconomic Implications of Rising Wage Inequality in the United States," Journal of Political Economy, University of Chicago Press, vol. 118(4), pages 681-722, 08.
- Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2008. "The Macroeconomic Implications of Rising Wage Inequality in the United States," NBER Working Papers 14052, National Bureau of Economic Research, Inc.
- Benjamin A. Malin, 2005.
"Hyperbolic Discounting and Uniform Savings Floor,"
04-034, Stanford Institute for Economic Policy Research.
- Attanasio, Orazio P & Weber, Guglielmo, 1995.
"Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey,"
Journal of Political Economy,
University of Chicago Press, vol. 103(6), pages 1121-57, December.
- Orazio P. Attanasio & Guglielmo Weber, 1994. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," NBER Working Papers 4795, National Bureau of Economic Research, Inc.
- Robert J. Barro, 1999. "Ramsey Meets Laibson in the Neoclassical Growth Model," The Quarterly Journal of Economics, Oxford University Press, vol. 114(4), pages 1125-1152.
- Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 175-200, Fall.
- Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," NBER Working Papers 13265, National Bureau of Economic Research, Inc.
- R. A. Pollak, 1968. "Consistent Planning," Review of Economic Studies, Oxford University Press, vol. 35(2), pages 201-208.
When requesting a correction, please mention this item's handle: RePEc:fip:fedpwp:14-1. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Beth Paul)
If references are entirely missing, you can add them using this form.