The Impact of Consumer Credit Access on Earnings Mobility, Entrepreneurship and Income Inequality

Project Outcomes Statement

Our primary objective was to explore the implications of credit access for labor market outcomes. In particular, we merged family level credit reports with administrative Census data, including the Decennial Census, Longitudinal Employer Household Dynamics (LEHD) database, and the Integrated Longitudinal Business Dynamics (ILBD) database. This data merge provided the first comprehensive picture of family structure, parental borrowing capacity, and the labor market and educational outcomes of children. The new data merge allows future researchers in economics and social sciences to better understand the role of credit in both intergenerational transmission of inequality as well as the interaction between default/borrowing and income dynamics, consumption smoothing, and a host of other topics.

With the data constructed, we developed a draft paper entitled “Intergenerational mobility and credit” (by J. Carter Braxton, Nisha Chikhale, Kyle Herkenhoff, and Gordon Phillips) in which we applied three instrumental variables to obtain the causal effects of parental revolving borrowing capacity (including credit cards an HELOCs) on child outcomes. To obtain exogenous variation in credit, we used bankruptcy flag removal of parents, variation in automatic limit increases stemming from differences in account ages, and variation in home equity due to differences in purchase cohorts.

We found that greater credit access of the parents led to (1) greater earnings of the children, regardless of whether the children went to college, (2) less quarters spent unemployed, (3) children working at firms with greater average earnings, and (4) a greater likelihood of completing college. The effects are also present for parents with and without college degrees.

We then developed a structural model of credit access and intergenerational mobility. Our model allows for parents to access defaultable debt markets and use those resources to invest in their children. The presence of parental bankruptcy and intergenerational linkages make our framework new to the literature. These features also allow us to simulate the instruments from our empirical analysis and thus use our empirical analysis to identify and discipline the parameters of our model. With the estimated model in hand, we assess how changes in the U.S. credit market since the 1970s have affected inequality, mobility, and outcomes for children.

Greater credit limits in the 2000s led to less inequality and more earnings mobility. On the other hand, weaker bankruptcy penalties in the 2000s led to weaker precautionary savings motives and weaker child investment motives. As a result of changes to bankruptcy institutions, inequality increased and earnings mobility fell from the 1970s to 2000s.

Our initial findings suggest that parental credit access is an important determinant of human capital formation of children, regardless of whether they attend college or not. Bankruptcy institutions affect parental investments in children, and thus our results will inform the debate over bankruptcy reform. Bankruptcy flags and parental exclusion from credit markets following a default have major effects on children's outcomes. These costs must be factored into the debate over streamlining the bankruptcy process.