Household Need for Liquidity and the Credit Card Debt Puzzle

Abstract

In the 2001 U.S. Survey of Consumer Finances (SCF), 27% of households report simultaneously revolving significant credit card debt and holding sizeable amounts of low-return liquid assets; this is known as the "credit card debt puzzle". In this paper, I quantitatively evaluate the role of liquidity demand in accounting for this puzzle: households that accumulate credit card debt may not pay it off using their money in the bank, because they anticipate needing that money in situations where credit cards cannot be used. I characterize the puzzle in survey data, and calibrate a dynamic stochastic heterogeneous-agent model of household portfolio choice, where consumer credit and liquidity coexist as means of consumption and saving, where households consume a cash good and a credit good, and where cash consumption is subject to uncertainty. The model accounts for between 44% and 56% of the households in the data who hold consumer debt and liquidity simultaneously, and for 100% of the liquidity held by a median such household. Under reasonable calibration alternatives, the model can capture the entire puzzle group size as well. One-half of money demand in the model is precautionary. * I am indebted to Vìctor Rìos-Rull, Randall Wright, Jesùs Fernàndez-Villaverde and Dirk Krueger for their guidance in this project. For many helpful discussions and suggestions, I thank Kjetil Storesletten and three anonymous referees, as well as

Saving more in groups: Field experimental evidence from Chile

“…3 In other settings, it seems that households are quite good at making optimal decisions about saving vs. borrowing (Telyukova, 2013;Zinman, 2015). For a more detailed discussion, see Section 2.1.…”

“…With respect to whether it is optimal for participants to hold debt and assets at the same time (condition 1 above), Telyukova (2013) shows that people hold (credit card) debt and "low return liquid assets" (such as cash in the bank) because of transaction frictions (see also the evidence in Zinman, 2007). She finds that a substantial fraction of households keep cash because they anticipate situations where they cannot use their credit card and will therefore need to access their liquid assets.…”

Why Do Poor People Co-Hold Debt and Liquid Savings?

“…Telyukova (2013) shows that much of households' co-holding behaviour is explained by liquidity needs, precisely by the amount and volatility of cash-only consumption, that is, the goods for which a credit card cannot be used. Similarly, Fulford (2015a) estimates his model using crosssectional data from the 2007 US SCF and proves that the variability of credit limits explains much of households' co-holding behaviour.…”

How Important is Variability in Consumer Credit Limits?

“…The checks sent by credit card companies to use for cash advances even suggest their use for emergencies. That the credit card puzzle has held constant at the same time as the precautionary need based on transactions suggested by Telyukova and Wright (2008) and Telyukova (2013) has largely disappeared strongly suggests that another explanation is needed. The Telyukova and Wright (2008) Bankruptcy.…”