Senior debt

Cognition

Psychiatry

Economics

Anxiety

Household debt

Debt levels and flows

Psychology

Internal debt

Recourse debt

Monetary economics

Demographic economics

Public economics

Debt

Poverty

Debt-to-GDP ratio

Economic growth

Clinical psychology

Finance

External debt

Proceedings of the National Academy of Sciences

Significance The impact of chronic debt on the poor is psychological, not just financial. We hypothesize that chronic debt impairs psychological functioning and decision-making, contributing to the poverty trap. This is because debt is not considered fungible and is viewed as costly mental accounts that consume cognitive bandwidth. We test this using quasiexperimental evidence from a one-off, unanticipated debt-relief program worth several months’ household income. Comparing the poor before and after debt relief, those with more debt accounts paid off experienced greater improvements in cognitive functioning, reported less anxiety, and became less present-biased. These findings provide actionable evidence for poverty-alleviation policy.

Reducing debt improves psychological functioning and changes decision-making in the poor