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Precautionary borrowing and the credit card debt puzzle

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  • Jeppe Druedahl
  • Casper Nordal Jørgensen

Abstract

This paper addresses the credit card debt puzzle using a generalization of the buffer‐stock consumption model with long‐term revolving debt contracts. Closely resembling actual US credit card law, we assume that card issuers can always deny their cardholders access to new debt, but that they cannot demand immediate repayment of the outstanding balance. Hereby, current debt can potentially soften a household's borrowing constraint in future periods, and thus provides extra liquidity. We show that for some intermediate values of liquid net worth it is indeed optimal for households to simultaneously hold positive gross debt and positive gross assets even though the interest rate on the debt is much higher than the return rate on the assets. Including a risk of being excluded from new borrowing which is positively correlated with unemployment, we are able to simultaneously explain a substantial share of the observed borrower‐saver group and match a broad range of percentiles from the empirical distributions of credit card debt and liquid assets.

Suggested Citation

  • Jeppe Druedahl & Casper Nordal Jørgensen, 2018. "Precautionary borrowing and the credit card debt puzzle," Quantitative Economics, Econometric Society, vol. 9(2), pages 785-823, July.
    • Handle: RePEc:wly:quante:v:9:y:2018:i:2:p:785-823
    DOI: 10.3982/QE604
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    Cited by:

    1. Bahadir, Berrak & De, Kuhelika & Lastrapes, William D., 2020. "Household debt, consumption and inequality," Journal of International Money and Finance, Elsevier, vol. 109(C).
    2. Pulina, Giuseppe, 2024. "Credit card debt puzzle: Evidence from the euro area," Economics Letters, Elsevier, vol. 236(C).
    3. Piotr Bialowolski & Andrzej Cwynar & Dorota Weziak‐Bialowolska, 2024. "Credit purpose and the interest rate – Evidence from the European Household Finance and Consumption Survey," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 29(1), pages 162-176, January.
    4. Olafsson, Arna & Gathergood, John, 2020. "The Co-holding Puzzle: New Evidence from Transaction-Level Data," CEPR Discussion Papers 14799, C.E.P.R. Discussion Papers.
    5. Chunchun Chen & Chengchun Li & Guoying Ren, 2022. "The effect of present‐biased preferences on revolving debts: Evidence from urban households in China," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(3), pages 2653-2668, July.
    6. Kondratjeva, Olga & Roll, Stephen P. & Bufe, Sam & Grinstein-Weiss, Michal, 2021. "Using financial tips to guide debt repayment: Experimental evidence from low- and moderate-income tax filers," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 90(C).
    7. Dodini, Samuel & Larrimore, Jeff & Tranfaglia, Anna, 2024. "Financial repercussions of SNAP work requirements," Journal of Public Economics, Elsevier, vol. 229(C).
    8. Ryszard Kowalski & Grzegorz Wałęga, 2022. "Regulation of Usury: Justification, Consequences, and Some Lessons from Polish Experience," Gospodarka Narodowa. The Polish Journal of Economics, Warsaw School of Economics, issue 2, pages 57-73.
    9. Francisco Gomes & Michael Haliassos & Tarun Ramadorai, 2021. "Household Finance," Journal of Economic Literature, American Economic Association, vol. 59(3), pages 919-1000, September.
    10. Carroll, Christopher D. & Holm, Martin B. & Kimball, Miles S., 2021. "Liquidity constraints and precautionary saving," Journal of Economic Theory, Elsevier, vol. 195(C).
    11. Giuseppe Pulina, 2023. "Consumer debt in Luxembourg and the euro area: Evidence from the Household Finance and Consumption Survey," BCL working papers 175, Central Bank of Luxembourg.

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