Consumer Credit With Over-Optimistic Borrowers

By Florian Exler, Igor Livshits, James MacGee and Michèle Tertilt

http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2020_245&r=dge (paper is the first on the list once you click on this link)

There is active debate over whether borrowers’ cognitive biases create a need for regulation to limit the misuse of credit. To tackle this question, we incorporate overoptimistic borrowers into an incomplete markets model with consumer bankruptcy. Lenders price loans, forming beliefs—type scores—about borrowers’ types. Since over-optimistic borrowers face worse income risk but incorrectly believe they are rational, both types behave identically. This gives rise to a tractable theory of type scoring as lenders cannot screen borrower types. Since rationals default less often, the partial pooling of borrowers generates cross-subsidization whereby over-optimists face lower than actuarially fair interest rates. Over-optimists make financial mistakes: they borrow too much and default too late. We calibrate the model to the US and quantitatively evaluate several policies to address these frictions: reducing the cost of default, increasing borrowing costs, imposing debt limits, and providing financial literacy education. While some policies lower debt and filings, they do not reduce over-borrowing. Financial literacy education can eliminate financial mistakes, but it also reduces behavioral borrowers’ welfare by ending cross-subsidization. Score-dependent borrowing limits can reduce financial mistakes but lower welfare.

Borrowing is a form of leveraging your assets. The better the prospects, the more you should leverage. The problem is with those who misread the prospects and are over-optimistic. And if you cannot identify those, it is actually pretty difficult to correct for these biases without reducing overall welfare.

Advertisement

On the Purchasing Power of Money in an Exchange Economy

By Juliusz Radwanski

http://d.repec.org/n?u=RePEc:pra:mprapa:104244&r=dge

A model is constructed in which completely unbacked fiat money, issued by generic supplier implementing realistically specified monetary policy designed to obey certain sufficient conditions, is endogenously accepted by rational individuals at uniquely determined price level. The model generalizes Lucas (1978) to an economy with frictions and specialization in production, without imposing the cash-in-advance constraint. The uniqueness of equilibrium is the consequence of complete characterization of both the environment, and the equilibrium concept. The results challenge the doctrine that equilibria of monetary economies are inherently indeterminate, and that money can become worthless only due to self-fulfilling expectations. The paper shows that monetary policy canonically features two dimensions, one of which corresponds to nominal interest rate, and the other to continuous helicopter drop of net worth, which in the model takes the form of universal basic income.

The topic of the existence and emergence of money is fascinating. This paper takes it to the next level by using Lucas (1978) *without* cash-in-advance and *without* backing. Pretty impressive.

Optimal quantitative easing in a monetary union

By Serdar Kabaca, Renske Maas, Kostas Mavromatis and Romanos Priftis

http://d.repec.org/n?u=RePEc:dnb:dnbwpp:697&r=dge

This paper explores the optimal allocation of government bond purchases within a monetary union, using a two-region DSGE model, where regions are asymmetric with respect to economic size and portfolio characteristics: the extent of substitutability between assets of different maturity and origin, asset home bias, and steady-state levels of government debt. An optimal quantitative easing (QE) policy under commitment does not only reflect different region sizes, but is also a function of these dimensions of portfolio heterogeneity. By calibrating the model to the euro area, we show that optimal QE favors purchases from the smaller region (Periphery instead of Core), given that the former faces stronger portfolio frictions. A fully optimal policy consisting of both the short-term interest rate and QE lifts the monetary union away from the zero lower bound faster than an optimal interest rate policy alone, which entails forward guidance.

Central banks are really hesitant to take on policies that are not uniform across their sphere of influence, because of obviously political consequences. But it is also clear that any uniform policy can most likely be improved on by some heterogeneity. This paper illustrates this.

Short-Run Dynamics in a Search-Theoretic Model of Monetary Exchange

By Jonathan Chiu and Miguel Molico

http://d.repec.org/n?u=RePEc:bca:bocawp:20-48&r=dge

We study the short-run effects of monetary policy in a search-theoretic monetary model in which agents are subject to idiosyncratic liquidity shocks as well as aggregate monetary shocks. Namely, we analyze the role of the endogenous non-degenerate distribution of liquidity, liquidity constraints, and decentralized trade in the transmission and propagation of monetary policy shocks. Money is injected through lump-sum transfers, which have redistributive and persistent effects on output and prices. We propose a new numerical algorithm in the spirit of Algan, Allais and Den Haan. (2008) to solve the model. We find that a one-time expansionary monetary policy shock has persistent positive effects on output, prices, and welfare, even in the absence of nominal rigidities. Furthermore, the effects of positive and negative monetary shocks are typically asymmetric. Negative (contractionary) shocks have bigger effects than positive (expansionary) shocks. In addition, in an economy with larger shocks, the responses tend to be disproportionately larger than those in an economy with smaller shocks. Finally, the effectiveness of monetary shocks depends on the steady-state level of inflation. The higher the average level of inflation (money growth), the bigger the impact effect of a shock of a given size but the smaller its cumulative effect. These results are consistent with existing empirical evidence.

This paper is representative of a severely understudied literature: computational money search. While “regular” money search has provided a lotof important insights, it is constrained by analytic tractability. Going the computation route go overcome so many limitations, but somehow very people venture in this area. This paper shows the potential of computing rich dynamics that are impossible with an analytic model.