Default and Credit Constraints in General Equilibrium

A recent strand of the literature convincingly demonstrates that both the sovereign default and the household default are properly explained by models in which agents face uninsurable income shocks, while being allowed to strategically default on their debt. We develop a similar model in a general equilibrium setting, and we prove that the market equilibrium features overborrowing as well as too much default: if default may be individually optimal, it can deter the ex ante welfare. We show that regulating the credit market through borrowing constraints contributes to increase the aggregate welfare. More precisely, we characterize the path of optimal credit constraint in general equilibrium and for in…nite horizon economy.