The purposes of this paper are to understand functions of consumer finance from the perspective of economics, and to consider some possible measures to improve further the functions of consumer finance.
Consumer finance is an important means to stimulate or advance aggregate consumption from the macro-economic perspective. From the micro-economic perspective, consumer finance is an essential device to achieve dynamic optimization of consumption apart from the time constraint of income flow. By performing this function, consumer finance enhances the welfare level of consumers.
This welfare enhancing function of consumer finance can be maintained even in the world of uncertainty. In the case of symmetric information, Arrow=Debreu securities assure optimality of market equilibrium even under the assumption of uncertainty. This idea of Arrow=Debreu securities can be applied, to some extent, to contracts of consumer finance, such as risk-based loan rate and some covenants of partial exemption of repayment in the case of unexpected income loss.
Asymmetric information may incur the well-known problems of adverse selection and moral hazard. But, even in these cases, there are some possible remedies against the problems, for example, self-selection device against the former, and credit rationing against the latter.
According to Experimental Economics, consumers are not as rational as standard economics assumes. My research by questionnaires about subjective discount rates suggests people’s natural tendency of excessive immediate consumption.
Fair and competitive market of consumer finance is a prerequisite condition for enjoying an increase in welfare that consumer finance will bring in. A well-organized credit information system is also a prerequisite to cope well with asymmetric information problems. Sharing credit information of applicants is crucial to manage well the problems of adverse selection and moral hazard. Moreover, considering some inadequacy of human cognitive ability and tendency of over-immediate consumption, some sort of consumer education programs will be necessary.
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