Lending Standards and Consumption Insurance over the Business Cycle

How much do changes in credit supply affect consumers’ ability to insure against income risk over the business cycle and what is the valuation of such insurance? Using loan-level data from the Senior Loan Officer Opinion Survey (SLOOS), we construct measures of key credit supply variables, such as lending standards and terms for consumer credit in the U.S. and build a heterogeneous model of unsecured credit and default that accounts for credit supply dynamics as estimated from these data. Our economy is quantitatively consistent with key features of the unsecured credit market, earnings dynamics, and measures of consumption volatility in the U.S. We find that variability in standards and terms for credit is welfare improving despite the loss in consumption insurance that such an environment may induce. The key mechanism behind this result is the asymmetric effect that changes in standards induce for loan pricing in good and bad states of the economy.