How important is variability in consumer credit limits?

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Credit limit variability is a crucial aspect of the consumption, savings, and debt decisions of households in the United States. Using a large panel, this paper first demonstrates that individuals gain and lose access to credit frequently and often have their credit limits reduced unexpectedly. Credit limit volatility is larger than most estimates of income volatility and varies over the business cycle. While typical models of intertemporal consumption fix the credit limit, I introduce a model with variable credit limits. Variable credit limits create a reason for households to hold both high interest debts and low interest savings at the same time, since the savings act as insurance. Simulating the model using the estimates of credit limit volatility, I show that it explains all of the credit card puzzle: why around a third of households in the United States hold both debt and liquid savings at the same time. The approach also offers an important new channel through which financial system uncertainty affects household decisions. Terms of use: Documents in EconStor mayJEL Classifications: E21, D91, D14

Precautionary borrowing and the credit card debt puzzle

“…Closest to our paper are Attanasio, Leicester, and Wakefield (2011), Attanasio, Bottazzi, Low, Nesheim and Wakefield (2012), Halket and Vasudev (2014) and Chen, Michaux, and Roussanov (2015) who all introduce long-term mortgage contracts, and Alan, Crossley, and Low (2012) who model the "credit crunch" of 2008 in terms of a drying up of new borrowing (a flow constraint) instead of a recall of existing loans (the typical change in the stock constraint). 3 To the best of our knowledge, Fulford (2015) is the only other paper that investigated the importance of multiperiod debt contracts for the credit card debt puzzle. 4 Our approach differs from his in a number of important ways.…”

“…Additionally, we allow the risk of losing access to new borrowing to be positively correlated with unemployment and show that this is empirically relevant and quantitatively important for explaining a sizable puzzle group. This is especially important because we, in contrast to Fulford (2015), account for the forced monthly repayments contained in standard credit card contracts and a more realistic income process-with both permanent and transitory shocks and nonzero growthwhich otherwise considerably weakens the ability of the precautionary borrowing motive to explain a sizable puzzle group.…”

“…On a more technical note, the model we present in this paper explicitly, in contrast to Fulford's (2015) model, nests the canonical buffer-stock consumption model as a limiting case, and can be solved by a state-of-the-art endogenous grid point method for models with nonconvex choice sets. This is first beneficial because it allows us to conduct a range of important robustness tests, such as showing which preferences must characterize puzzle households and that a sizable puzzle group can be explained for a wide range of estimates for the risk of losing and regaining access to new borrowing.…”

Noncognitive Abilities and Financial Delinquency: The Role of Self‐Efficacy in Avoiding Financial Distress

“…However, many credit applications are submitted for current financing rather than on a precautionary basis. Furthermore, credit lines might be an ineffective form of insurance against future shocks, as borrowing limits can be (and often are) reduced or eliminated at the lender's discretion (see Fulford () and Druedahl and Jorgensen ()).…”

The Impact of Automated Reminders on Credit Outcomes: Results from an Experimental Pilot Program

“…Credit is an important component of the financial lives of consumers. For U.S. households, revolving credit like that available through credit cards comprises approximately two‐thirds of the funds available for short‐term consumption in a given period (Fulford ). Research indicates that 40% to 60% of U.S. consumers do not pay their credit card balances in full each month, resulting in the accrual of interest on unpaid balances that can place strain on household budgets (Consumer Financial Protection Bureau ; Laibson, Repetto, and Tobacman ).…”