Intertemporal Choice and Legal Constraints

M. Keith Chen

University of California, Los Angeles (UCLA) - Anderson School of Management; Yale School of Management; Cowles Foundation

Alan Schwartz

Yale Law School

American Law & Economics Review, Forthcoming
Yale SOM Working Paper
Yale Law & Economics Research Paper No. 432

We study the effect of legal constraints in an environment in which agents face demand shocks they would like to smooth, but also have weakness of will: agents' long and short run preferences are misaligned. Some agents are sophisticated -- they know they will make inconsistent intertemporal choices -- while other agents are naive. The consequent public policy problem is complex. The state should facilitate consumer borrowing to help agents smooth consumption and cushion the effect of shocks, but should also facilitate pre-commitment, to help agents control excessive present-biased preferences. We show that in many simple settings, naive and sophisticated agents make similar consumption/savings choices, which simplifies the policy problem. We also show that all agents borrow when they experience consumption shocks, and that agents with relatively strong present-biased preferences who face relatively mild consumption shocks will borrow to finance excessive current consumption. Other agents save appropriately. Legal constraints that severely restrict agents' access to credit thus would be over-inclusive. Offering agents access to both a liquid and an illiquid savings vehicle appears to be welfare improving relative to either allowing agents complete freedom to borrow or strongly restricting their access to the credit market. Creating and regulating such vehicles are public goods that the market will not supply.

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Date posted: May 10, 2011 ; Last revised: May 26, 2011

Suggested Citation

Chen, M. Keith and Schwartz, Alan, Intertemporal Choice and Legal Constraints. American Law & Economics Review, Forthcoming; Yale SOM Working Paper; Yale Law & Economics Research Paper No. 432. Available at SSRN: https://ssrn.com/abstract=1836522

Contact Information

Keith Chen
University of California, Los Angeles (UCLA) - Anderson School of Management ( email )
110 Westwood Plaza
Los Angeles, CA 90095-1481
United States
HOME PAGE: http://www.anderson.ucla.edu/faculty/keith.chen/index.html
Yale School of Management ( email )
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-6049 (Phone)
HOME PAGE: http://www.som.yale.edu/faculty/keith.chen

Cowles Foundation
Box 208281
New Haven, CT 06520-8281
United States

Alan Schwartz (Contact Author)
Yale Law School ( email )
P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-4030 (Phone)
203-432-8260 (Fax)

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