Macro Seminar: Eric Young, University of Virginia

Speaker

The Department Welcomes Professor Eric Young, University of Virginia

Title

"Consumer Credit Regulation and Lender Market Power"

Abstract

We investigate the welfare consequences of consumer credit regulation in a dynamic, heterogeneous-agent model with an explicit role for lenders’ market power. We incorporate a decentralized credit market with search and incomplete information frictions in an off-the- shelf Eaton-Gersowitz model of consumer credit and default. Lenders post credit offers and borrowers can apply to multiple lenders, however some borrowers are informed and direct their applications toward the lowest offers while others are uninformed and apply randomly. Equilibrium features price dispersion — controlling for a borrower’s default risk, there exists both high- and low-cost lending. Importantly, the distribution of loan prices and the extent of lenders’ market power is disciplined by borrowers’ outside options. We calibrate the model to match characteristics of the unsecured consumer credit market, including high-cost options such as payday loans. We use the calibrated model to evaluate interest rate caps. In a model with a competitive financial market, caps can only harm borrower welfare. In contrast, with lender market power interest rate caps can raise borrower welfare by reducing markups, but that requires households have some degree of financial illiteracy (lack of information about interest rates).