How Important is Variability in Consumer Credit Limits?

Abstract

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 can affect household decisions.JEL classification: E21, D91, D14

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. Zinman (2007) also uses a dataset from the 2004 US SCF to evaluate the cost of co-holding debt and liquid savings.…”

“…3 The theory of liquidity needs-originally formulated by Telyukova and Wright (2008) and Zinman (2007), and later extended by Fulford (2015a)-highlights that liquid deposits are valuable to households for transactions and precautionary 4 purposes. The reason is twofold.…”

Credit Card Utilization and Consumption Over the Life Cycle and Business Cycle

“…Our analysis is limited to the potential or actual credit-card-using population of the United States because credit card use is what gives us insight into behavior. More than 70 percent of the U.S. population has a credit card at any given time, and a larger fraction has a credit card at some point, because gaining and losing access is common (Fulford 2015). We limit the sample from the credit bureau to include only accounts that have a birth year and that had an open credit card account at some point from 1999-2015.…”

Diverse Effects of Consumer Credit on Household Carbon Emissions at Quantiles: Evidence from Urban China

“…This budget constraint suggests that consumer credit as well income and wealth change will have impacts on household total consumptions and each consumption category. Consumer credit reduces households' financing constraints and improves the ability to regulate consumption across present and future periods [27,28]. As there is dispute about the endogeneity in the relation of consumer credit and consumption, we emphasize the correlation between consumer credit and household consumption.…”