Bankruptcy exemptions, borrowing constraints, and old-age pensions

Governments design public pension programs primarily to secure adequate living standards for the entire, retired population. Governments also routinely install bankruptcy protections that protect a minimum standard of living for a small group of loan defaulters postbankruptcy. This paper studies how these two policies, one designed for the entire population and the other designed for a small group, interact. The setting is a dynamically-efficient economy where young borrowers face endogenous borrowing limits due to an inability to commit to repayment in middle age. In this framework, generous income protections for defaulters incentivize lenders to limit credit to the entire population, reducing everyone’s youthful debt burden, and raising middle-age incomes, and consumption during retirement – a goal of public pensions. All this, however, comes at a cost: reduced credit market efficiency. Our key finding is that public pensions can increase retirement consumption for everyone provided pension payouts to defaulters, a small group, are protected by bankruptcy statutes.