How important is variability in consumer credit limits?
This paper demonstrates that credit limit variability is a crucial aspect of the consumption, savings, and debt decisions of households in the United States. While typical models of intertemporal consumption fix the credit limit, 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. This approach can explain the credit card puzzle: why around a third of households in the U.S. hold both debt and liquid savings at the same time. Unlike other approaches it is consistent with observed changes over time. It also offers an important new channel for financial system uncertainty to affect household decisions. One of the largest "assets" in the portfolio of U.S. households is their ability to borrow. Increased uncertainty about credit limits reduces the value of this asset, and so has effects similar to a decline in wealth.
|Date of creation:||01 Sep 2010|
|Date of revision:||19 Oct 2012|
|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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