A New Test of Borrowing Constraints for Education

Models of investment and borrowing for education typically treat the family as a unitary decision-maker. Doing so may conceal the nature of borrowing constraints, since adults with college-age children are likely at a life-cycle stage where credit constraints are not important. We instead propose a simple model of altruistic parents and a child where both parties can make investments for education and for other purposes and parents can transfer cash to their child. The model implies that educational investment is inefficient for intergenerationally constrained parent-child pairs. The constraint arises because parents of constrained children rationally do not pay the share of college expenses that is assumed by federal financial aid formulas. The model highlights new empirical implications of borrowing constraints for education, which we examine making use of data from the Health and Retirement Study and the NLSY-97. The data are consistent with quantitatively important borrowing constraints for higher education.