Open AccessRising indebtedness and temptation: A welfare analysis
Author(s) -
Nakajima Makoto
Publication year - 2012
Publication title -
quantitative economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 4.062
H-Index - 27
eISSN - 1759-7331
pISSN - 1759-7323
DOI - 10.3982/qe87
Subject(s) - temptation , economics , consumption (sociology) , welfare , consumption smoothing , limit (mathematics) , constraint (computer aided design) , microeconomics , monetary economics , econometrics , macroeconomics , business cycle , market economy , mathematics , psychology , social psychology , social science , mathematical analysis , geometry , sociology
Is the observed large increase in consumer indebtedness since 1970 beneficial for U.S. consumers? This paper quantitatively investigates the macroeconomic and welfare implications of relaxing borrowing constraints using a model with preferences featuring temptation and self‐control. The model can capture two contrasting views: the positive view, which links increased indebtedness to financial innovation and thus better consumption smoothing, and the negative view, which is associated with consumers' overborrowing . I find that the latter is sizable: the calibrated model implies a social welfare loss equivalent to a 0.4 percent decrease in per‐period consumption from the relaxed borrowing constraint consistent with the observed increase in indebtedness. The welfare implication is strikingly different from the standard model without temptation, which implies a welfare gain of 0.7 percent, even though the two models are observationally similar. Although both models imply welfare gains from a tighter borrowing limit than in 2000s, the optimal borrowing limit is tighter according to the temptation model, as a tighter borrowing limit helps consumers avoiding overborrowing.