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Household Need for Liquidity and the Credit Card Debt Puzzle

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Author Info
Telyukova, Irina A.

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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 liquid assets. These consumers report paying, on average, a 14% interest rate on their debt, while earning only 1 or 2% on their liquid deposit accounts. This phenomenon is known in the literature as the “credit card debt puzzle.” In this paper, I pose and quantitatively evaluate the following explanation for this puzzle: households that accumulate credit card debt may not pay it off using their money in the bank, because they expect to use that money for goods for which credit cards cannot be used. Using both aggregate and survey data (SCF and CEX), I document that liquid assets are a substantial part of households’ portfolios and that consumption in goods requiring liquid payments may have a sizeable unpredictable component. This would warrant holding precautionary balances in liquid accounts. I develop a dynamic heterogeneous-agent model of household portfolio choice, where households are subject to uninsurable income and preference uncertainty, and consumer credit and liquidity coexist as means of consumption and saving/borrowing. The calibration of the model parameters is based on the simulated method of moments. The calibrated model accounts for 73% of the households in the data who hold consumer debt and liquidity simultaneously, and for at least 55 cents of every dollar held by a median household in the puzzle group. I argue that these results are a lower bound, and that the liquidity-need hypothesis is thus successful in rendering most of the puzzle a rational phenomenon.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 6674.

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Date of creation: 26 Dec 2007
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Handle: RePEc:pra:mprapa:6674

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Find related papers by JEL classification:
D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
D14 - Microeconomics - - Household Behavior - - - Personal Finance

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    Other versions:
  4. Irina A Telyukova & Randall Wright, 2008. "A Model of Money and Credit, with Application to the Credit Card Debt Puzzle," Review of Economic Studies, Blackwell Publishing, vol. 75(2), pages 629-647, 04. [Downloadable!] (restricted)
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  5. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & Jose-Victor Rios-Rull, 2007. "A quantitative theory of unsecured consumer credit with risk of default," Working Papers 07-16, Federal Reserve Bank of Philadelphia. [Downloadable!]
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  23. Vincenzo Quadrini & José-Víctor Ríos-Rull, 1997. "Understanding the U.S. distribution of wealth," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr, pages 22-36. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Marcus Hagedorn, 2007. "A Monetary Model with Strong Liquidity Effects," IEW - Working Papers iewwp353, Institute for Empirical Research in Economics - IEW. [Downloadable!]
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