Publication Date: February 2013
Revision Date: March 2016
This paper examines the equilibrium eﬀects of alternative ﬁnancial aid policies intended to promote college participation. We build an overlapping generations life-cycle, heterogeneous-agent, incomplete-markets model with education, labor supply, and consumption/saving decisions. Driven by both altruism and paternalism, parents make inter vivos transfers to their children. Both cognitive and non-cognitive skills determine the non-pecuniary cost of schooling. Labor supply during college, government grants and loans, as well as private loans, complement parental resources as means of funding college education. We ﬁnd that the current ﬁnancial aid system in the U.S. improves welfare, and removing it would reduce GDP by 4-5 percentage points in the long-run. Further expansions of government-sponsored loan limits or grants would have no salient aggregate eﬀects because of substantial crowding-out: every additional dollar of government grants crowds out 30 cents of parental transfers plus an equivalent amount through a reduction in student’s labor supply. However, a small group of high-ability children from poor families, especially girls, would greatly beneﬁt from more generous federal aid.
Education, Education policy, Public ﬁnance, Financial aid, Inter vivos transfers, Altruism, Overlapping generations, Credit constraints, Labor supply, Equilibrium
JEL Classification Codes: E24, I22, J23, J24