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Intergenerational mobility and credit

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Empirical findings illuminate the impact of parental credit access on children's earnings

In the last fifty years, more and more people have been able to get personal credit. This change affects families, especially parents and their children, in different ways. Personal credit can help parents invest in their children's education and overcome tough financial times. However, there has also been a rise in people declaring bankruptcy because it has become cheaper to do so. This trend towards easier debt relief might lead parents to take on more debt than they can handle, which could reduce their ability to support their children's growth and education.

Our recent paper looks into how parents' access to credit impacts their children's lives, particularly how it affects the children's future earnings and chances for success. We created a novel dataset that links parents' use of credit and their income with how much money their children make when they start working. We use the removal of negative marks on credit reports as a way to study this, treating it like a natural experiment. We found that kids who grow up in families with better access to credit tend to earn more when they become adults (around 25 to 30 years old). They are also more likely to finish college, spend less time unemployed, and land jobs at well-paying companies. We see this as proof that these children gain valuable skills and knowledge. This suggests that when families have better access to credit, they can manage money more smoothly and continue to support their children's growth and learning.

These empirical findings illuminate the impact of parental credit access on children's earnings but stop short of exploring its wider implications for inequality and mobility. To delve into this issue, we construct a quantitative economic model that simulates the decisions of parents and their offspring, encompassing savings, investments in children's human capital, and choices regarding default in the face of income volatility. Crucially, we calibrate this model to align with our empirical observations.

Using our quantitative model as a laboratory, we examine the repercussions of expanded credit limits and reduced bankruptcy expenses in the US spanning the 1970s through the early 2000s. The introduction of lower bankruptcy costs prompts households—particularly those with lower incomes—to diminish their savings and accrue greater debt, driven by the reduced penalties for debt discharge during adverse financial events. This shift leads households to approach their borrowing limits more closely and curtail their investments in their children’s education and development, thereby diminishing the children’s human capital and prospective earnings. This pattern is especially detrimental to lower-income families, exacerbating intergenerational mobility constraints and widening inequality gaps. Although the extension of borrowing limits somewhat mitigates these effects, the predominant influence of decreasing bankruptcy costs leads to a net decrease in intergenerational mobility and an amplification of economic inequality.

© Carter Braxton, Nisha Chikhale, Kyle Herkenhoff, and Gordon Phillips

John Carter Braxton is Assistant Professor of Economics at the University of Wisconsin-Madison and IZA Research Affiliate
Nisha Chikhale is Ph.D. candidate in Economics at the University of Wisconsin-Madison
Kyle Herkenhoff is Associate Professor of Economics at the University of Minnesota and IZA Research Fellow
Gordon Phillips is the Laurence F. Whittemore Professor of Business Administration and Professor of Finance at Tuck School of Business at Dartmouth

Please note:
We recognize that IZA World of Labor articles may prompt discussion and possibly controversy. Opinion pieces, such as the one above, capture ideas and debates concisely, and anchor them with real-world examples. Opinions stated here do not necessarily reflect those of the IZA.

Related IZA World of Labor content:
Intergenerational return to human capital by Paul J. Devereux
Intergenerational income persistence by Jo Blanden
School tracking and intergenerational social mobility by Tuomas Pekkarinen
Do school inputs crowd out parents’ investments in their children? by Birgitta Rabe

Foto by Alexander Grey on Unsplash