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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 & Andrew A. Samwick, 1995. "The Nature of Precautionary Wealth," NBER Working Papers 5193, National Bureau of Economic Research, Inc.
  2. Kjetil Storesletten & Chris Telmer & Amir Yaron, 1997. "Consumption and risk sharing over the life cycle," GSIA Working Papers 228, Carnegie Mellon University, Tepper School of Business.
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  4. Geoffrey R. Gerdes, 2008. "Recent payment trends in the United States," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Oct, pages A75-A106.
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  7. 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.
  8. David B. Gross & Nicholas S. Souleles, 2002. "Do Liquidity Constraints and Interest Rates Matter for Consumer Behavior? Evidence from Credit Card Data," The Quarterly Journal of Economics, Oxford University Press, vol. 117(1), pages 149-185.
  9. Pierre-Olivier Gourinchas & Jonathan A. Parker, 1999. "Consumption Over the Life Cycle," NBER Working Papers 7271, National Bureau of Economic Research, Inc.
  10. Irina A. Telyukova, 2007. "Household Need for Liquidity and the Credit Card Debt Puzzle," 2007 Meeting Papers 515, Society for Economic Dynamics.
  11. Christopher D Carroll & Miles S Kimball, 2001. "Liquidity Constraints and Precautionary Saving," Economics Working Paper Archive 455, The Johns Hopkins University,Department of Economics.
  12. Christopher D. Carroll, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 1-55.
  13. 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.
  14. Christopher D. Carroll, 2001. "A Theory of the Consumption Function, With and Without Liquidity Constraints (Expanded Version)," NBER Working Papers 8387, National Bureau of Economic Research, Inc.
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  18. Chow, Gregory C., 1997. "Dynamic Economics: Optimization by the Lagrange Method," OUP Catalogue, Oxford University Press, number 9780195101928, July.
  19. 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.).
  20. Jonathan Zinman, 2009. "Where Is The Missing Credit Card Debt? Clues And Implications," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 55(2), pages 249-265, 06.
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  24. Deaton, A., 1989. "Saving And Liquidity Constraints," Papers 153, Princeton, Woodrow Wilson School - Public and International Affairs.
  25. Edelberg, Wendy, 2006. "Risk-based pricing of interest rates for consumer loans," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 2283-2298, November.
  26. Anil K Kashyap & Owen A. Lamont & Jeremy C. Stein, 1994. "Credit Conditions and the Cyclical Behavior of Inventories," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 565-592.
  27. Scott Fulford, 2012. "The precaution of the rich and poor," Boston College Working Papers in Economics 814, Boston College Department of Economics.
  28. Steven Stern, 1997. "Simulation-Based Estimation," Journal of Economic Literature, American Economic Association, vol. 35(4), pages 2006-2039, December.
  29. 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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