Theory of College, Student Loans, and Education Policy

Rodolfo Manuelli, Carlos Garriga () and Maria Ferreyra
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Maria Ferreyra: The World Bank

No 1319, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: This paper analyzes the effectiveness of three different types of education policies: tuition subsidies (broad based, merit based, and flat tuition), grant subsidies (broad based and merit based), and loan limit restrictions. We develop a quantitative theory of college within the context of general equilibrium overlapping generations economy. College is modeled as a multi-period risky investment with endogenous enrollment, time-to-degree, and dropout behavior. Tuition costs can be financed using federal grants, student loans, and working while at college. We show that our model accounts for the main statistics regarding education (enrollment rate, dropout rate, and time to degree) while matching the observed aggregate wage premiums. Our model predicts that broad based tuition subsidies and grants increase college enrollment. However, due to the correlation between ability and financial resources most of these new students are from the lower end of the ability distribution and eventually dropout or take longer than average to complete college. Merit based education policies counteract this adverse selection problem but at the cost of a muted enrollment response. The importance of loan availability critically depends on the underlying distribution of abilities.

Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:1319

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