Unsecured Debt with Public Insurance: From Bad to Worse
FRB Richmond Working Paper No. 03-14R
40 Pages Posted: 3 Dec 2012
Date Written: November 24, 2004
In U.S. data, income interruptions, the receipt of public insurance, and the incidence of personal bankruptcy are all closely related. The central contribution of this paper is to evaluate both bankruptcy protection and public insurance in a unified setting where each program alters incentives in the other. Specifically, we explicitly allow for distortion created by the default option and public insurance to affect 1) risk-taking, 2) borrowing, and 3) search effort. Our analysis delivers two striking conclusions. First, we find that U.S. personal bankruptcy law is an important barrier to allowing the public insurance system to improve welfare. Second, contrary to popular belief, we find that increases in the generosity of public insurance will lead to more, not less, bankruptcy.
Keywords: incomplete markets, bankruptcy, unemployment
JEL Classification: D52, G33, J64
Suggested Citation: Suggested Citation