E2022021                                                                 2022-11-10
 

JOYDEEP BHATTACHARYA

Iowa State University

MONISANKAR BISHNU

ISI, Delhi; CAMA; CEPAR

MIN WANG

NSD, Peking University

Abstract

Time-inconsistent agents lack the internal commitment to stick to consumption plans and may “overborrow.” Some also fail to commit to repaying externally obtained loans. We study credit market contracts in a lifecycle setting where agents suffer from internal and external commitment problems. There are no income or consumption shocks by design, and the credit market is perfectly competitive. With unrestricted credit, agents with only the internal commitment problem cannot achieve either the first-best or the fully sophisticated equilibrium allocations. When such agents, in addition, suffer from a lack of external commitment, lenders endogenously impose borrowing limits which, prima facie, look a lot like the abilityto-repay rules consumer financial protection agencies impose. We find, even with restricted credit access, except under special circumstances, agents suffering from the twin commitment problems can achieve, at most, fully sophisticated allocations. The government can achieve the first-best allocations if and only if it is assisted with endogenously imposed borrowing limits.
 

Keywords: endogenous borrowing constraints, CFPB, ability-to-pay rule, overborrowing, financial Protection

JEL: E 21, E 70, G 40, G 28

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