Academic Research

Consumer Bankruptcy

Work In Progress

Costly Contracts and Consumer Credit (Working Paper Version)

Joint with Igor Livshits (University of Western Ontario) and Michele Tertilt (Stanford University).

ABSTRACT: Financial innovations are a common explanation of the rise in consumer credit and bankruptcies. To evaluate this story, we develop a simple model that incorporates two key frictions: asymmetric information about borrowers' risk of default and a fixed cost to create each contract offered by lenders. Innovations which reduce the fixed cost or ameliorate asymmetric information have large extensive margin effects via the entry of new lending contracts targeted at riskier
borrowers. This results in more defaults and borrowing, as well as increased dispersion of interest rates. Using the Survey of Consumer Finance and interest rate data collected by the Board of Governors, we find evidence supporting these predictions, as the dispersion of credit card interest rates nearly tripled, and the share of credit card debt of lower income households nearly doubled.


Accounting for the Rise in Consumer Bankruptcies in the United States

Joint with Igor Livshits (University of Western Ontario) and Michele Tertilt (Stanford University).
American Economic Journal Macroeconomics, April 2010, 165-193.

ABSTRACT: Personal bankruptcies in the United States have increased dramatically, rising from 1.4 per thousand working age population in 1970 to 8.5 in 2002. We use a heterogeneous agent life-cycle model with competitive financial intermediaries who can observe households' earnings, age and current asset holdings to evaluate several commonly offered explanations. We find that increased uncertainty (income shocks, expense uncertainty) cannot quantitatively account for the rise in bankruptcies. Instead, stories related to a change in the credit market environment are more plausible. In particular, we find that a combination of a decrease in the transactions cost of lending and a decline in the cost of bankruptcy does a good job in accounting for the rise in consumer bankruptcy. We also argue that the abolition of usury laws and other legal changes are unimportant.

Web Appendix

Consumer Bankruptcy: A Fresh Start (pdf) 

Joint with Igor Livshits (University of Western Ontario) and Michele Tertilt (Stanford University).
American Economic Review, March 2007.

ABSTRACT: There has been considerable public debate on the relative merits of alternative consumer bankruptcy rules. The option to discharge one's debt provides partial insurance against bad luck, but by driving up interest rates makes life-cycle smoothing more difficult. We construct a quantitative model of consumer bankruptcy to address this trade-off. We argue that such a model should have three key feature: a life-cycle component, idiosyncratic earnings uncertainty and expense uncertainty (exogenous negative shocks to household balance sheets). We further show that transitory and persistent earnings shocks have very different implications for evaluating bankruptcy rules -- while persistent shocks make bankruptcy option desirable, transitory shocks have the opposite implication. Our findings suggest that the current US bankruptcy system may be desirable for reasonable parameter values.

An earlier and substantially different version of this paper --which includes a comparison with Germany and a labour supply choice not contained in the revised version --circulated under the same title:

Consumer Bankruptcy: A Fresh Start (pdf) 

Joint with Igor Livshits (University of Western Ontario) and Michele Tertilt (Stanford University).
Federal Reserve Bank of Minneapolis Working Paper 617.

ABSTRACT: American consumer bankruptcy provides for a Fresh Start through the discharge of a household's debt. Until recently, many
European countries specified a No Fresh Start policy of life-long liability for debt. The policy trade-off is that while Fresh Start provides insurance across states, it drives up interest rates and thereby makes life-cycle smoothing more difficult. This paper quantitatively compares these bankruptcy rules using a life-cycle model with incomplete markets calibrated to the U.S. and Germany. A key innovation is that households face idiosyncratic uncertainty about their net asset holdings (expense shocks) and labor income. We find that expense uncertainty plays a key role in evaluating consumer bankruptcy laws.

The Great Depression

Work In Progress

A Multi-Sectoral Approach to the U.S. Great Depression

Joint with Pedro Amaral (Federal Reserve Bank of Cleveland)

We quantify the role of contractionary monetary shocks and wage rigidities in the U.S. Great Contraction. While the average economy-wide real wage varied little over 1929-33, real wages rose signi cantly in some industries. We calibrate a two-sector
model with intermediates to the 1929 U.S. economy where wages in one sector adjust slowly. We nd that nominal wage rigidities can account for less than a fth of the fall in GDP over 1929-33. Intermediate linkages play a key role, as the output decline in our
benchmark is roughly half as large as in our two-sector model without intermediates.

Relative Prices, Trade and the Canadian Great Depression (Coming Soon)

Joint with Pedro Amaral (Federal Reserve Bank of Cleveland).

ABSTRACT: Canada suffered a major depression from 1929 to 1939, with GNP per capita falling by roughly 40 percent relative to trend between 1929 and 1933. Although both the decline and the slow recovery of GDP per adult over 1934-39 are very similar to that of the American Great Depression, there are two important distinctions. First, (measured) total factor productivity in Canada recovered much more slowly relative to trend over 1934-39 than in the United States. Second, trade was a much more important part of the Canadian economy, with exports and imports each accounting for roughly a quarter of Canadian GDP in 1928. Moreover, the trade share of GDP fell by roughly 50 percent between 1928 and 1933, before slowly recovering during the late 1930's. We document that the decline in the trade-GDP ratio was accompanied by a decline of over 20 percent in the relative prices of exports and imports relative to non-traded goods. This paper examines whether this change in relative prices was an important factor in the decline in GDP per adult and measured TFP in Canada. We employ an open economy model with multiple sectors and reallocation frictions to quantify how much of the decline and the slow recovery in TFP can be accounted for by this mechanism..



The Great Depression in Canada and the United States: A Neoclassical Analysis (pdf)

Joint with Pedro Amaral (Southern Methodist University).(Review of Economic Dynamics, January 2002, 45-72, reprinted in Great Depressions of the Twentieth Century.).

ABSTRACT: Canada suffered a major depression from 1929 to 1939. In terms of output it was similar to the Great Depression in the United States. However, total factor productivity (TFP) in Canada did not recover relative to trend, while in the United States TFP had recovered by 1937. We find that the neoclassical growth model, with TFP treated as exogenous, can account for over half of the decline in output relative to trend in Canada. In contrast, we find that conventional explanations for the Great Depression - monetary shocks, terms of trade shocks and labor market and competition policies – do not work for Canada.

Data for this paper can be found at:

Other Papers

Private Pensions, Retirement Wealth and Lifetime Earnings, EPRI Working Paper 2010-2.

Joint with Jie Zhou (Nanyang Technological University)

This paper investigates the effect of private pensions on the retirement wealth distribution. We incorporate stochastic private pension coverage into a calibrated life-cycle model with stochastic earnings. While private pensions lead to higher wealth inequality, the model generates less inequality in retirement wealth than observed in the PSID. We find that a life-cycle model with private pensions, heterogeneous life-cycle earnings profiles and permanent return differences across households can largely account for the sizeable variation in retirement wealth.

Supplementary Appendix

Vested Interests and Technology Adoption (pdf).
Joint with Benjamin Bridgman and Igor Livshits (University of Western Ontario).

Journal of Monetary Economics, April 2007.

The asymmetric ability of different interest groups to exclude non-members and the concentrated benefits and diffused costs of policies favoring vested interests matters for technology adoption. We analyze a political economy model where coalitions of workers in many small industries lobby government for a prohibition on the adoption of superior technologies. For reasonable parameter values, the ``smallness'' of industry lobbies leads to barriers to the adoption of technologies that would make \emph{all} workers more productive. Higher government corruption can lead to lower levels of TFP and per capita output. The model can generate TFP growth cycles..

The following paper complements the "Vested Interests" paper.

  • For Sale: Barriers to Riches (pdf).

    Joint with Benjamin Bridgman and Igor Livshits (University of Western Ontario). EPRI Working Paper 2004-3.

    ABSTRACT: This paper formalizes stories linking vested interests to the non-adoption of superior technologies. Coalitions of workers skilled in the operation of incumbent technologies lobby government for a prohibition on the adoption of better technologies. For reasonable parameter values, we find that the model generates significant levels of protection in equilibrium. The model also generates protection cycles that lead to TFP growth cycles. Protection has a level effect on per capita output. ``Productivity slowdowns'' lead to increased levels of protection. The level of protection is increasing in the venality of governments. Increased population growth rates increase the value of protection, and can lead to an increase in the level of protection.

    Barriers to Technology Adoption and Entry (pdf).

  • Joint with Igor Livshits (University of Western Ontario).

    A key feature of recent work on barriers to technology adoption is the assumption that monopoly rights of insiders are limited by the ability of industry outsiders to enter. This paper endogenizes the decision of a government to provide barriers to technology adoption alone or in combination with barriers to entry of outsiders. Using a political economy model, we find that a government provides barriers to both technology adoption and outsider entry. If governments are not too ``corrupt", restricting their ability to provide barriers to entry may eliminate barriers to adoption. However, for sufficiently ``corrupt" governments, prohibiting barriers to entry leads to more extreme barriers to technology adoption.

  • What Broad Banks Do, and Markets Don't: Cross Subsidization (pdf)
  •  (Updated September 2007)

    Joint with Thor Koeppl (Queens University),

    European Economic Review.

    ABSTRACT: We show that interbank markets are a poor substitute for ``broad'' banks that operate across regions or sectors. In the presence of regional or sectoral asset and liquidity shocks, interbank markets can distribute liquidity efficiently, but fail to respond efficiently to asset shocks. Broad banks can condition on the joint distribution of both shocks and, hence, achieve an efficient internal allocation of capital. This allocation involves the cross-subsidization of loans across regions or sectors. Compared to regional banks that are linked through well-functioning interbank markets, broad banks lead to higher levels of aggregate investment, higher output, and less fluctuations within regions. However, broad banks generate endogenously aggregate uncertainty..

    Earlier versions of this project circulated as:

  • Limited Enforcement and Efficient Interbank Arrangements
  •  Limited Enforcement and Efficient Interbank Arrangements
  •   (This is an older version available as Federal Reserve Bank of Minneapolis Working Paper 608)
    Joint with Thor Koeppl (European Central Bank), .

    ABSTRACT: Banks have historically provided mutual insurance against asset risk, where the insurance arrangement itself was characterized by limited enforcement. This paper shows that a non-trivial interaction between asset and liquidity risk plays a crucial role in shaping optimal banking arrangements in the presence of limited enforcement. We find that liquidity shocks are essential for the provision of insurance against asset shocks, as they mitigate interbank enforcement problems. These enforcement problems generate endogenous aggregate uncertainty as investment allocations depend upon the joint distribution of shocks. Paradoxically, a negative correlation between liquidity and asset shocks ameliorates enforcement limitations and facilitates interbank cooperation.


    Land Titles, Credit Markets and Wealth Distributions (Wider Research Paper No. 2006/150)

    ABSTRACT: Does the existence of formal title to land and real estate matter for the distribution of wealth? This paper reviews the empirical literature on the economic impact of land and real estate administration systems across countries. This paper argues that a functioning credit market for secured credit is necessary to realize the full benefits of legal title to private real estate. This paper also reviews quantitative economic theory on wealth distribution to assess the likely impact of different land registration systems on wealth inequality. The implication of current theory is that poor land administration systems may sometimes lead to lower levels of wealth inequality than better land registration systems.

    In: James B. Davies (ed.), Personal Assets from a Global Perspective, Oxford University Press for the United Nations University (UNU) World Institute for Development Economics Research (WIDER), 334-352, 2008