Consumer debt and bankruptcy are central issues today because of their explosive trends over the last 20 years in the U.S. economy. This paper provides a theory to quantify how much of the rise in debt and bankruptcy can be
attributed to the drop in information costs. In the model, lenders offer contracts specifying both interest rates and borrowing limits. In equilibrium, the contracts with low interest rates have tight borrowing limits, while those with high interest rates have loose borrowing limits. Despite being borrowing constrained, low-risk individuals prefer to borrow at the low interest rate. As the costs of information drop, it may be possible to explicitly condition loans on an individual’s risk. This allows previously borrowing constrained individuals to borrow more. As a consequence, there is also more bankruptcy. The quantitative importance of this mechanism is then investigated by calibrating the model’s parameters to match moments for the years 1983 and 2004. The main finding is that the drop in information costs alone generates around 40% of the total rise in consumer bankruptcy.
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Other files:
NBER WP,
Slides.
How does technological progress in financial intermediation affect the economy? To address this question a costly-state verification framework is embedded into a standard growth model. In particular, financial intermediaries can invest resources to monitor the returns earned by firms. The inability to monitor perfectly leads to firms earning rents. Undeserving firms are financed, while deserving ones are under funded. A more efficient monitoring technology squeezes the rents earned by firms. With technological advance in the financial sector, the economy moves continuously from a credit-rationing equilibrium to a perfectly efficient competitive equilibrium. A numerical example suggests that finance is important for growth.
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Other files:
Slides.
This paper considers the problem of optimal unemployment insurance in a repeated moral hazard framework. Unlike existing literature, unemployed workers can secretly participate in a hidden labor market. In the
initial phase of unemployment, the optimal contract prescribes no participation in the hidden labor market and a
decreasing sequence of unemployment payments. As payments drop, hidden labor market participation becomes more attactive. The next phase starts when the worker is indifferent between participating or staying out of the hidden
labor market. During this phase, participation remains at zero and the payments’ profile becomes flatter. For sufficiently large unemployment spells the last phase starts. At the beginning of this phase, participation jumps and unemployment payments drop down to zero.
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Since the probability of finding a job is affected not only by individual effort but also by the
aggregate state of the economy, designing unemployment insurance schemes conditional on the
business cycles could be valuable. This paper answers a fundamental question related to this issue:
How should the payments vary with the aggregate state of the economy? The finding is that, if
an increase in effort decreases the probability of staying unemployed proportionally more during a
boom than during a recession, then unemployment payments should decrease faster during booms
than during recessions.
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