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A Debt Puzzle

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Author Info
David Laibson
Andrea Repetto
Jeremy Tobacman

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Abstract

Over 60% of US households with credit cards are currently borrowing -- i.e., paying interest -- on those cards. We attempt to reconcile the high rate of credit card borrowing with observed levels of life cycle wealth accumulation. We simulate a lifecycle model with five properties that create demand for credit card borrowing. First, the calibrated labor income path slopes upward early in life. Second, income has transitory shocks. Third, consumers invest actively in an illiquid asset, which is sufficiently illiquid that it can not be used to smooth transitory income shocks. Fourth, consumers may declare bankruptcy, reducing the effective cost of credit card borrowing. Fifth, households have relatively more dependents early in the life-cycle. Our calibrated model predicts that 20% of the population will borrow on their credit card at any point in time, far less than the observed rate of over 60%. We identify a resolution to this puzzle: hyperbolic time preferences. Simulated hyperbolic consumers borrow actively in the revolving credit card market and accumulate relatively large stocks of illiquid wealth, matching observed data.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7879.

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Date of creation: Sep 2000
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Handle: RePEc:nbr:nberwo:7879

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Find related papers by JEL classification:
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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  1. Blundell, Richard & Browning, Martin & Meghir, Costas, 1994. "Consumer Demand and the Life-Cycle Allocation of Household Expenditures," Review of Economic Studies, Blackwell Publishing, vol. 61(1), pages 57-80, January. [Downloadable!] (restricted)
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  2. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  3. Deaton, Angus S & Muellbauer, John, 1986. "On Measuring Child Costs: With Applications to Poor Countries," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 720-44, August. [Downloadable!] (restricted)
  4. B. Douglas Bernheim & Jonathan Skinner & Steven Weinberg, 1997. "What Accounts for the Variation in Retirement Wealth Among U.S. Households?," Working Papers 97035, Stanford University, Department of Economics. [Downloadable!]
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  5. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(1992-2), pages 61-156. [Downloadable!]
  6. Brito, Dagobert L & Hartley, Peter R, 1995. "Consumer Rationality and Credit Cards," Journal of Political Economy, University of Chicago Press, vol. 103(2), pages 400-433, April. [Downloadable!] (restricted)
  7. Deaton, Angus, 1991. "Saving and Liquidity Constraints," Econometrica, Econometric Society, vol. 59(5), pages 1221-48, September. [Downloadable!] (restricted)
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  8. David I. Laibson & Andrea Repetto & Jeremy Tobacman, 1998. "Self-Control and Saving for Retirement," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1998-1), pages 91-196. [Downloadable!]
  9. Hubbard, R. Glenn & Skinner, Jonathan & Zeldes, Stephen P., 1994. "The importance of precautionary motives in explaining individual and aggregate saving," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 40(1), pages 59-125, June. [Downloadable!] (restricted)
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  10. David B. Gross & Nicholas S. Souleles, 1999. "An Empirical Analysis of Personal Bankruptcy and Delinquency," Center for Financial Institutions Working Papers 98-28, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
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  11. Ausubel, Lawrence M, 1991. "The Failure of Competition in the Credit Card Market," American Economic Review, American Economic Association, vol. 81(1), pages 50-81, March.
  12. Pierre-Olivier Gourinchas & Jonathan A. Parker, 1999. "Consumption Over the Life Cycle," NBER Working Papers 7271, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Zeldes, Stephen P, 1989. "Consumption and Liquidity Constraints: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 97(2), pages 305-46, April. [Downloadable!] (restricted)
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  14. Robert J. Barro, 1997. "Myopia and Inconsistency in the Neoclassical Growth Model," NBER Working Papers 6317, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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