Working Paper

Employer Credit Checks: Poverty Traps versus Matching Efficiency

Abstract: We develop a framework to understand the effects of pre-employment credit screening in both labor and credit markets. People differ in both their propensity to default on debt and the profits they create for firms that employ them. In our calibrated economy, workers with a low default probability are highly productive and therefore generate more profits for their employers; thus, firms create more jobs for those with good credit. However, using credit reports to screen job applicants creates a poverty trap: an unemployed worker with poor credit has a low job-finding rate and cannot improve their credit without a job. In the calibrated economy, this manifests as an endogenous loss in the present value of lifetime wages that is roughly half of the amount widely used in quantitative models of consumer default. Banning employer credit checks eliminates the poverty trap, but job seekers with good and bad credit now apply to the same jobs, which reduces matching efficiency. As a result, average job-finding rates fall 1.3 percent for high-productivity workers and rise by 1.7 percent for low-productivity workers.

Keywords: pre-employment credit screening; consumer default; adverse selection; credit;

JEL Classification: E20; E24;

https://doi.org/10.18651/RWP2023-01

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 2023-01-06

Number: RWP 23-01