Default, insurance, and debt over the life-cycle

The widespread use of debt and default suggests that unsecured credit markets play an important role in consumption smoothing. In this paper, I address two previously unanswered questions. First, how does policy towards debt default affect the evolution of consumption and net worth over the life-cycle? Second, how does debt default policy interact with social insurance over the life-cycle? The findings are as follows. First, US default policy appears “lax”, in the sense that it creates severe credit constraints, especially for the young. Second, eliminating default will lower consumption inequality among the young, but will increase it among the old. Third, social insurance alters default risk and, in turn, loan pricing, and therefore matters for purely intertemporal smoothing.