Economics Working Papers

Publication Date

4-3-2020

Number

20006

Abstract

This paper studies the welfare of time-inconsistent, partially sophisticated agents living under two different regimes, one with complete, unfettered credit markets (CM) and the other with endogenous borrowing constraints (EBC) where the borrowing limits are set to make agents indifferent between defaulting and paying back their unsecured loans. The CM regime cannot deliver the first best because partially sophisticated agents would undo plans laid out by previous selves and borrow too much. Somewhat counterintuitively, in some cases, the EBC regime may deliver higher welfare than the CM regime. These results speak to the academic debate surrounding the creation and functioning of the CFPB (Consumer Financial Protection Bureau) in the U.S. and its implementation of the ability-to-repay rule on lenders after the 2007-8 crisis. Such institutions generate commitment publicly and may help time-inconsistent agents economize on the costs of private commitment provision.

JEL Classification

E21, G28

Version History

Original Release Date: April 3, 2020

Departments

Department of Economics, Iowa State University

File Format

application/pdf

Length

34 pages

Share

COinS