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How important is variability in consumer credit limits?

  • Scott Fulford

    (Boston College)

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.

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Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 754.

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Date of creation: 01 Sep 2010
Date of revision: 01 May 2014
Publication status: forthcoming, Journal of Monetary Economics
Handle: RePEc:boc:bocoec:754
Note: Previously circulated as "What credit card puzzle? Precaution, variable debt limits, and what we can learn from the small debts of poor people"
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  1. Christopher D. Carroll, 2004. "Theoretical Foundations of Buffer Stock Saving," Economics Working Paper Archive 517, The Johns Hopkins University,Department of Economics.
  2. David B. Gross & Nicholas S. Souleles, 2001. "Do Liquidity Constraints and Interest Rates Matter for Consumer Behavior? Evidence from Credit Card Data," NBER Working Papers 8314, National Bureau of Economic Research, Inc.
  3. Andreas Lehnert & Dean M. Maki, 2002. "Consumption, debt and portfolio choice: testing the effect of bankruptcy law," Finance and Economics Discussion Series 2002-14, Board of Governors of the Federal Reserve System (U.S.).
  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, Oxford University Press, vol. 75(2), pages 629-647.
  5. Chow, Gregory C., 1997. "Dynamic Economics: Optimization by the Lagrange Method," OUP Catalogue, Oxford University Press, number 9780195101928, March.
  6. Carol C. Bertaut & Michael Haliassos & Michael Reiter, 2009. "Credit Card Debt Puzzles and Debt Revolvers for Self Control," Review of Finance, European Finance Association, vol. 13(4), pages 657-692.
  7. David Laibson & Andrea Repetto & Jeremy Tobacman, 2000. "A Debt Puzzle," NBER Working Papers 7879, National Bureau of Economic Research, Inc.
  8. Steven Stern, 1997. "Simulation-Based Estimation," Journal of Economic Literature, American Economic Association, vol. 35(4), pages 2006-2039, December.
  9. Fulford, Scott L., 2013. "The effects of financial development in the short and long run: Theory and evidence from India," Journal of Development Economics, Elsevier, vol. 104(C), pages 56-72.
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