Tighter Credit and Consumer Bankruptcy Insurance
Marcel Peruffo and
No 14330, CEPR Discussion Papers from C.E.P.R. Discussion Papers
How does bankruptcy protection affect household balance sheet adjustments and aggregate consumption when credit tightens? Using a tractable model of unsecured consumer credit we quantify the trade-off between the insurance and the creditworthiness effects of bankruptcy in response to tighter credit. We show that bankruptcy dampens the effect of tighter credit on aggregate consumption on impact. This is because it allows borrowers to sustain consumption against severe financial distress. However, by leading to consumers' exclusion from the credit market for a certain period, bankruptcy also reduces their ability to smooth consumption over time, implying a slower recovery. The bankruptcy code establishes how costly it is to default, and, thus, plays a crucial role in determining consumers' bankruptcy decisions and in shaping consumption dynamics. We quantify that the 2005 BAPCPA reform, by making filing for bankruptcy more costly, worsened the negative welfare effects of the subsequent credit tightening.
Keywords: BAPCPA; Chapter 7; Deleveraging (search for similar items in EconPapers)
JEL-codes: E44 E52 E58 G21 G32 (search for similar items in EconPapers)
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