What is Borrowing Constraints?

MP Smartchap

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Borrowing Constraints​

Individuals are free to borrow or lend at the market interest rate. However, in reality, this may not always be the case. In particular, it is not clear that those wishing to borrow (with the willingness and ability to pay back their debt) can always do so. Likewise, a country that wishes to borrow may not always be able to obtain the credit that is desired. The reasons for why this may be the case are varied, but to the extent that it is true, then borrowers are said to face borrowing constraints that limit the amount that can be borrowed.

A skeptic may remark that the world is full of people (and countries) that would like to ‘borrow,’ while having little intention of paying back their debt. Or perhaps the intention is there, but some individuals may be overly optimistic concerning their ability to repay. The point here is that, in practice, it is difficult to know whether some individuals are truly debt-constrained or whether they would in fact be violating their intertemporal budget constraint. The challenge for theorists is to explain why creditors would refuse to lend to people (or countries) who are in a position to make good on their promise to repay.

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