Time inconsistency and endogenous borrowing constraints

Joydeep Bhattacharya, Monisankar Bishnu and Min Wang

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

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.

Keywords: endogenous borrowing constraints; overborrowing; financial protection (search for similar items in EconPapers)
JEL-codes: E21 E70 G28 G40 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2020-06
New Economics Papers: this item is included in nep-mac
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Working Paper: Time inconsistency and endogenous borrowing constraints (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2020-57

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