Precautionary Borrowing and the Credit Card Debt Puzzle

TY - UNPB

T1 - Precautionary Borrowing and the Credit Card Debt Puzzle

AU - Druedahl, Jeppe

AU - Jørgensen, Casper Nordal

PY - 2015/10/8

Y1 - 2015/10/8

N2 - 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 in- termediate values of financial 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 high level of liquid net worth.

AB - 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 in- termediate values of financial 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 high level of liquid net worth.

KW - Faculty of Social Sciences

KW - household balance sheets

KW - Models

KW - Other economic analyses

KW - Credit Card Debt Puzzle

KW - Precautionary Saving

KW - Consumption

M3 - Working paper

T3 - Danmarks Nationalbank. Working Papers (Online)

BT - Precautionary Borrowing and the Credit Card Debt Puzzle

ER -