Boundedly Rational Borrowing: A Consumer's Guide

Abstract:     
Excessive borrowing, no less than insufficient savings, might be a product of bounded rationality. Identifiable psychological mechanisms are likely to contribute to excessive borrowing; these include myopia, procrastination, optimism bias, "miswanting," and what might be called cumulative cost neglect. Suppose that excessive borrowing is a significant problem for some or many; if so, how might the law respond? The first option involves weak paternalism, through debiasing and other strategies that leave people free to choose as they wish. Another option is strong paternalism, which forecloses choice. Because of private heterogeneity and the risk of government error, regulators should have a firm presumption against strong paternalism, and hence the initial line of defense against excessive borrowing consists of information campaigns, debiasing, and default rules. On imaginable empirical findings, however, there may be a plausible argument for strong paternalism in the form of restrictions on various practices, perhaps including "teaser rates" and late fees. The two larger themes, applicable in many contexts, involve the importance of an ex post perspective on the consequences of consumer choices and the virtues and limits of weak forms of paternalism, including debiasing and libertarian paternalism.

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