College Education and Income Contingent Loans in Equilibrium

We investigate the welfare implications of income-contingent loans (ICLs) used for financing college education in presence of the dropout risk that depends on unobservable effort. While providing insurance through ICLs increases college enrollment, it also generates a moral hazard cost of lowering educational effort. We evaluate this insurance-incentives trade-off in a heterogeneous agent OLG life-cycle model calibrated to the US. We show that ICLs significantly increase welfare, the social cost of moral hazard is mild, the endogeneity of skill premium significantly crowds-out effects of ICLs and that the non-linear repayment schedule is essential to delivering high welfare gains