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How important is variability in consumer credit limits?

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  • Fulford, Scott L.

    () (Boston College)

Abstract

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 affects household decisions.

Suggested Citation

  • Fulford, Scott L., 2010. "How important is variability in consumer credit limits?," Working Papers 14-8, Federal Reserve Bank of Boston, revised 01 May 2014.
  • Handle: RePEc:fip:fedbwp:14-8
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    References listed on IDEAS

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    Cited by:

    1. repec:gam:jsusta:v:9:y:2017:i:9:p:1563-:d:110715 is not listed on IDEAS
    2. Fulford, Scott L., 2015. "The surprisingly low importance of income uncertainty for precaution," European Economic Review, Elsevier, vol. 79(C), pages 151-171.
    3. Silva, Mario, 2017. "New monetarism with endogenous product variety and monopolistic competition," Journal of Economic Dynamics and Control, Elsevier, vol. 75(C), pages 158-181.
    4. Athreya, Kartik & Sánchez, Juan M. & Tam, Xuan S. & Young, Eric R., 2012. "Bankruptcy and delinquency in a model of unsecured debt," Working Papers 2012-042, Federal Reserve Bank of St. Louis, revised 22 Dec 2016.
    5. Carolina Laureti, 2015. "The Debt Puzzle in Dhaka’s Slums: Do Poor People Co-hold for Liquidity Needs?," Working Papers CEB 15-021, ULB -- Universite Libre de Bruxelles.
    6. Gorbachev, Olga & Luengo-Prado, Maria Jose, 2016. "The credit card debt puzzle: the role of preferences, credit risk, and financial literacy," Working Papers 16-6, Federal Reserve Bank of Boston.
    7. Stephanie Moulton & Donald Haurin & Samuel Dodini & Maximilian D. Schmeiser, 2016. "How Home Equity Extraction and Reverse Mortgages Affect the Credit Outcomes of Senior Households," Working Papers wp351, University of Michigan, Michigan Retirement Research Center.
    8. Fulford, Scott L. & Schuh, Scott, 2015. "Consumer revolving credit and debt over the life cycle and business cycle," Working Papers 15-17, Federal Reserve Bank of Boston.
    9. Carolina Laureti, 2017. "Why do Poor People Co-hold Debt and Liquid Savings?," Working Papers CEB 17-007, ULB -- Universite Libre de Bruxelles.

    More about this item

    Keywords

    credit card puzzle; intertemporal consumption; precaution; credit limits; household finance;

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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