Rising Indebtedness and Hyperbolic Discounting: A Welfare Analysis

Published in June 2009, October 2009, and April 2010.

The model can capture two contrasting views: The positive view, which links increased indebtedness to financial innovation and thus better insurance, and the negative view, which is associated with consumers' over-borrowing. The author finds that the latter is sizable: The calibrated model implies a social welfare loss equivalent to a 0.2 percent decrease in per-period consumption from the relaxed borrowing constraint consistent with the observed increase in indebtedness. The welfare implication is strikingly different from the model with the standard exponential discounting preference, which implies a welfare gain of 0.6 percent, even though the two models are observationally similar. Naturally, according to the hyperbolic discounting model, there is a welfare gain from restricting consumer borrowing in the current U.S. economy.