Working Paper 2017-08: Will Dobbie & Jae Song
Will Dobbie, Assistant Professor of Economics and Public Affairs at the Woodrow Wilson School of Public and International Affairs, Princeton University
Jae Song, Economist, Office of Disability Adjudication and Review, Social Security Administration
We study the drivers of financial distress using a large-scale field experiment that offered randomly selected borrowers a combination of (i) immediate payment reductions to target short- run liquidity constraints and (ii) delayed debt write-downs to target long-run debt constraints. We identify the separate effects of the payment reductions and debt write-downs using variation from both the experiment and cross-sectional differences in treatment intensity. We find that the debt write-downs significantly improved both financial and labor market outcomes despite not taking effect for three to five years. In sharp contrast, there were no positive effects of the more immediate payment reductions. These results run counter to the widespread view that financial distress is largely the result of short-run constraints.