Monday, June 29, 2015

Student Loans and the Bagehot Rule

As Prof Galle noted a few days ago, this blog has had a number of posts on student loans. I'm interested in the 2008 financial crisis, and I've been running across the Bagehot Rule a lot, which says that a central bank ought to make loans only if they will be profitable because the borrower is essentially sound, with good collateral, and is charged a high interest rate. Student loans sound similar--- the government supplies a missing market, and that ought to be profitable.

We do have the problem there, though, that borrowers might shortsightedly use the loans for consumption. I've talked about that in "Internalities and Paternalism: Applying Surplus Maximization to the Various Selves across Time." Social Choice and Welfare, 38(4): 601-615 (2012). It's abstract: One reason to call an activity a vice and suppress it is that it reduces a person's future happiness more than it increases his present happiness. Gruber & Koszegi (2001) show how a vice tax can increase a person's welfare in a model of multiple selves with hyperbolic preferences across time. An interself analogy of the compensation criterion can justify a vice ban whether preferences are hyperbolic or exponential, but subject to the caveat that the person has a binding constraint on borrowing.

  The multiple selves model, however, suggests that the present self, lacking in sufficient altruism, perhaps should not be allowed to mortgage the lives of his future selves by borrowing for consumption.

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