Evaluating default policy: The business cycle matters

Grey Gordon

Quantitative Economics, 2015, vol. 6, issue 3, 795-823

Abstract: More debt forgiveness directly benefits households but indirectly makes credit more expensive. How does aggregate risk affect this trade‐off? In a calibrated general equilibrium life‐cycle model, aggregate risk reduces the welfare benefit of making default very costly when the costs are borne by all households at all times. The result does not necessarily extend to state‐contingent policies. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 in particular generates a small welfare loss with or without aggregate risk.

Date: 2015
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