Working Paper: CEPR ID: DP14330
Authors: Antonio Antunes; Tiago Cavalcanti; Caterina Mendicino; Marcel Peruffo; Anne Villamil
Abstract: How does bankruptcy protection affect household balance sheet adjustments and aggregate consumption when credit tightens? Using a tractable model of unsecured consumer credit we quantify the trade-off between the insurance and the creditworthiness effects of bankruptcy in response to tighter credit. We show that bankruptcy dampens the effect of tighter credit on aggregate consumption on impact. This isbecause it allows borrowers to sustain consumption against severe financial distress. However, by leading to consumers’ exclusion from the credit market for a certain period, bankruptcy also reduces their ability to smooth consumption over time, implying a slower recovery. The bankruptcy code establishes how costly it is to default, and, thus, plays a crucial role in determining consumers’ bankruptcy decisions andin shaping consumption dynamics. We quantify that the 2005 BAPCPA reform, by making filing for bankruptcy more costly, worsened the negative welfare effects of the subsequent credit tightening.
Keywords: deleveraging; chapter 7; bapcpa
JEL Codes: E44; E52; E58; G21; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| tighter credit (E51) | reduced borrowing capacity (G32) |
| reduced borrowing capacity (G32) | affects aggregate consumption (E21) |
| bankruptcy (K35) | dampens the immediate impact of tighter credit on aggregate consumption (E21) |
| bankruptcy provides short-term relief (K35) | leads to exclusion from credit market (G21) |
| exclusion from credit market (G21) | reduces ability to smooth consumption over time (D15) |
| BAPCPA reform (K35) | worsens negative welfare effects of credit tightening (F65) |
| BAPCPA reform (K35) | significant impact on consumers' bankruptcy decisions (K35) |
| BAPCPA reform (K35) | affects consumption dynamics (E21) |