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A Debt Puzzle

  • David Laibson
  • Andrea Repetto
  • Jeremy Tobacman

Over 60% of US households with credit cards are currently borrowing -- i.e., paying interest -- on those cards. We attempt to reconcile the high rate of credit card borrowing with observed levels of life cycle wealth accumulation. We simulate a lifecycle model with five properties that create demand for credit card borrowing. First, the calibrated labor income path slopes upward early in life. Second, income has transitory shocks. Third, consumers invest actively in an illiquid asset, which is sufficiently illiquid that it can not be used to smooth transitory income shocks. Fourth, consumers may declare bankruptcy, reducing the effective cost of credit card borrowing. Fifth, households have relatively more dependents early in the life-cycle. Our calibrated model predicts that 20% of the population will borrow on their credit card at any point in time, far less than the observed rate of over 60%. We identify a resolution to this puzzle: hyperbolic time preferences. Simulated hyperbolic consumers borrow actively in the revolving credit card market and accumulate relatively large stocks of illiquid wealth, matching observed data.

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File URL: http://www.nber.org/papers/w7879.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7879.

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Date of creation: Sep 2000
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Publication status: published as Aghion, Philippe, Roman Frydman, Joseph Stiglitz, and Michael Woodford (eds.) Knowledge, Information and Expectations in Modern Macroeconomics: In Honor of Edmund S. Phelps. Princeton University Press, 2003.
Handle: RePEc:nbr:nberwo:7879
Note: AP EFG
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  1. B. Douglas Bernheim & Jonathan Skinner & Steven Weinberg, 2001. "What Accounts for the Variation in Retirement Wealth among U.S. Households?," American Economic Review, American Economic Association, vol. 91(4), pages 832-857, September.
  2. David I. Laibson & Andrea Repetto & Jeremy Tobacman, 1998. "Self-Control and Saving for Retirement," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 91-196.
  3. Stephen Zeldes, . "Consumption and Liquidity Constraints: An Empirical Investigation," Rodney L. White Center for Financial Research Working Papers 24-85, Wharton School Rodney L. White Center for Financial Research.
  4. Ausubel, Lawrence M, 1991. "The Failure of Competition in the Credit Card Market," American Economic Review, American Economic Association, vol. 81(1), pages 50-81, March.
  5. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
  6. David B. Gross & Nicholas S. Souleles, 1999. "An Empirical Analysis of Personal Bankruptcy and Delinquency," Center for Financial Institutions Working Papers 98-28, Wharton School Center for Financial Institutions, University of Pennsylvania.
  7. Deaton, Angus, 1991. "Saving and Liquidity Constraints," Econometrica, Econometric Society, vol. 59(5), pages 1221-48, September.
  8. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  9. Brito, Dagobert L & Hartley, Peter R, 1995. "Consumer Rationality and Credit Cards," Journal of Political Economy, University of Chicago Press, vol. 103(2), pages 400-433, April.
  10. O'Donoghue, Ted & Rabin, Matthew, 1997. "Doing It Now or Later," Department of Economics, Working Paper Series qt7t44m5b0, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  11. Blundell, Richard & Browning, Martin & Meghir, Costas, 1994. "Consumer Demand and the Life-Cycle Allocation of Household Expenditures," Review of Economic Studies, Wiley Blackwell, vol. 61(1), pages 57-80, January.
  12. Gourinchas, Pierre-Olivier & Parker, Jonathan A, 2000. "Consumption Over the Life-Cycle," CEPR Discussion Papers 2345, C.E.P.R. Discussion Papers.
  13. R. Glenn Hubbard & Jonathan Skinner & Stephen P. Zeldes, 1993. "The Importance of Precautionary Motives in Explaining Individual and Aggregate Saving," NBER Working Papers 4516, National Bureau of Economic Research, Inc.
  14. Robert J. Barro, 1997. "Myopia and Inconsistency in the Neoclassical Growth Model," NBER Working Papers 6317, National Bureau of Economic Research, Inc.
  15. Loewenstein, George & Prelec, Drazen, 1992. "Anomalies in Intertemporal Choice: Evidence and an Interpretation," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 573-97, May.
  16. Deaton, Angus S & Muellbauer, John, 1986. "On Measuring Child Costs: With Applications to Poor Countries," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 720-44, August.
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