Borrowing decisions affect most households, with large stakes and implications for research subfields as varied as macroeconomics and industrial organization. I review theoretical and empirical work on household debt: its prevalence, level, growth, and composition, as well as various measures of consumer choice and market (in)efficiency, elasticities, and prices, including new evidence on how borrowing heterogeneity affects the distribution of the opportunity cost of consumption. I also discuss opportunities and challenges in policy evaluation. A key takeaway is that puzzles abound, and I highlight numerous avenues for further research.
Household Need for Liquidity and the Credit Card Debt Puzzle
Abstract. In the 2001 U.S. Survey of Consumer Finances, 27% of households report simultaneously revolving significant credit card debt and holding sizeable
Household Finance
Household financial decisions are complex, interdependent, and heterogeneous, and central to the functioning of the financial system. We present an overview of the rapidly expanding literature on household finance (with some important exceptions) and suggest directions for future research. We begin with the theory and empirics of asset market participation and asset allocation over the life cycle. We then discuss household choices in insurance markets, trading behavior, decisions on retirement saving, and financial choices by retirees. We survey research on liabilities, including mortgage choice, refinancing, and default, and household behavior in unsecured credit markets, including credit cards and payday lending. We then connect the household to its social environment, including peer effects, cultural and hereditary factors, intra-household financial decision-making, financial literacy, cognition, and educational interventions. We also discuss literature on the provision and consumption of financial advice.
Liquidity versus Wealth in Household Debt Obligations: Evidence from Housing Policy in the Great Recession
We exploit variation in mortgage modifications to disentangle the impact of reducing long-term obligations with no change in short-term payments ("wealth"), and reducing short-term payments with no change in long-term obligations ("liquidity"). Using regression discontinuity and difference-in-differences research designs with administrative data measuring default and consumption, we find that principal reductions that increase wealth without affecting liquidity have no effect, while maturity extensions that increase only liquidity have large effects. This suggests that liquidity drives default and consumption decisions for borrowers in our sample and that distressed debt restructurings can be redesigned with substantial gains to borrowers, lenders, and taxpayers.
Debt and the Response to Household Income Shocks: Validation and Application of Linked Financial Account Data
The increasing availability of data derived from linked consumer financial accounts has the potential to dramatically expand the potential for research. Examining the most comprehensive existing set of linked-account data, consisting of transaction and balance sheet data for millions of Americans, I demonstrate the power and versatility of such sources. I discuss advantages and concerns arising from this type of data and match a range of distributional moments to external sources. As one application, I test consumption elasticities across households with varying levels, and types, of debt. I find that heterogeneity in consumption elasticity can be explained entirely by credit and liquidity.
Exponential Growth Bias and Household Finance
ABSTRACT Exponential growth bias is the pervasive tendency to linearize exponential functions when assessing them intuitively. We show that exponential growth bias can explain two stylized facts in household finance: the tendency to underestimate an interest rate given other loan terms, and the tendency to underestimate a future value given other investment terms. Bias matters empirically: More‐biased households borrow more, save less, favor shorter maturities, and use and benefit more from financial advice, conditional on a rich set of household characteristics. There is little evidence that our measure of exponential growth bias merely proxies for broader financial sophistication.
Credit Card Debt and Consumer Payment Choice: What Can We Learn from Credit Bureau Data?
We estimate a two-stage Heckman selection model of credit card adoption and use with a unique dataset that combines administrative data from the Equifax credit bureau and self-reported data from a representative survey of consumers. Higher-income consumers carry higher credit card balances, but they tend to repay those balances each month. Credit card revolvers have lower income and are less educated. Revolvers are twice as likely to use debit cards as credit cards for payments, but they carry much higher balances on their credit cards. The high cost of paying off credit card debt likely exacerbates existing inequalities in disposable income. Unlike the mortgage market, we find no evidence for lenders’ cutoff between subprime and prime consumers in the credit card market.
A Debt Puzzle
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.
What Would You Do with $500? Spending Responses to Gains, Losses, News, and Loans
Abstract We use survey questions about spending in hypothetical scenarios to investigate features of propensities to consume that are useful for distinguishing between consumption theories. We find that (1) responses to unanticipated gains are vastly heterogeneous (either zero or substantially positive); (2) responses increase in the size of the gain, driven by the extensive margin of spending adjustments; (3) responses to losses are much larger and more widespread than responses to gains; and (4) even those with large responses to gains do not respond to news about future gains. These four findings suggest that limited access to disposable resources, and frictions in adjusting consumption, are important determinants of consumption behaviour. We also find that (5) households do not respond to the offer of a one-year interest-free loan, suggesting that this is not a consequence of short-term credit constraints; and (6) people do cut spending in response to news about future losses, suggesting that neither is this a consequence of myopia. A calibrated precautionary savings model with utility costs of changing consumption, and a sufficient fraction of low-wealth households, can account for these features of propensities to consume on both the extensive and intensive margins.
The Debt Payment Puzzle: An Experimental Investigation
Why do borrowing individuals fail to repay their debt optimally? We design a diagnostic laboratory experiment where we rule out selection into debt and other co
The Co-holding Puzzle: New Evidence from Transaction-Level Data
Using detailed and highly disaggregated data on household finances, we examine the<br>tendency of consumers to “co-hold” savings and debt simultaneously. The di
Consumption and Debt Response to Unanticipated Income Shocks: Evidence from a Natural Experiment in Singapore
This paper uses a unique panel dataset of consumer financial transactions to study how consumers respond to an exogenous unanticipated income shock. Consumption rose significantly after the fiscal policy announcement: during the ten subsequent months, for each $1 received, consumers on average spent $0.80. We find a strong announcement effect—19 percent of the response occurs during the first two-month announcement period via credit cards. Subsequently, consumers switched to debit cards after disbursement before finally increasing spending on credit cards in the later months. Consumers with low liquid assets or with low credit card limit experienced stronger consumption responses. (JEL D12, D14, E21)
Cash versus Debit Card: The Role of Budget Control
Due to the financial crisis, an increasing number of households face financial problems. This may lead to an increasing need for monitoring spending and budgets. We demonstrate that both cash and the debit card are perceived as helpful in this respect. We show that, on average, consumers responsible for financial decision making within a household find cash and the debit card equally helpful for monitoring their household finances. Individuals differ in major respects, however. In particular, low earners and the liquidity‐constrained prefer cash as a budgeting tool. Finally, we present evidence that at an aggregated level, such preferences strongly affect consumer payment behavior. These findings suggest that the substitution of cash by cards may slow down because of the financial crisis.
Intra-Household Frictions, Anchoring, and the Credit Card Debt Puzzle
Abstract I study how intra-household frictions and anchoring contribute to the credit card debt puzzle, the co-holding of high-cost debt, and low-yield liquid assets. First, I find couples co-hold 42% more as units than as individuals relative to income. Moreover, in a natural experiment, couples do not cooperate to reduce high-cost debt, suggesting that intra-household frictions contribute to co-holding. Second, I find individuals who regularly make credit card debt payments equal to or near the minimum account for 59% of individual co-holding. The evidence suggests anchoring to the minimum payment contributes to co-holding via these low payments.
Credit Crises, Precautionary Savings, and the Liquidity Trap*
Abstract We study the effects of a credit crunch on consumer spending in a heterogeneous-agent incomplete-market model. After an unexpected permanent tightening in consumers’ borrowing capacity, constrained consumers are forced to repay their debt, and unconstrained consumers increase their precautionary savings. This depresses interest rates, especially in the short run, and generates an output drop, even with flexible prices. The output drop is larger with sticky prices, if the zero lower bound prevents the interest rate from adjusting downward. Adding durable goods to the model, households take larger debt positions and the output response can be larger.
Leave Home without it? The Effects of Credit Card Debt and Available Credit on Spending
This research examines how credit card debt affects consumer spending. In five experimental and field studies, the authors demonstrate that outstanding credit card debt increases spending for consumers with high self-control. They also show that this effect can be eliminated by increasing the available credit on the credit card. Thus, when the available credit is low, consumers with greater self-control increase spending, but when the available credit is high, they reduce spending. The results extend the literature on goal violation and self-control and offer insights into consumer decision making and consumption patterns under conditions of debt.
Does Saving Cause Borrowing? Implications for the Coholding Puzzle
ABSTRACT Using an experiment in which 3.1 million bank customers were encouraged to save, we explore the mechanisms behind coholding liquid savings and credit card debt. Theoretically, we show that the joint responses of spending, saving, and borrowing to the nudge differ across economic models of coholding. Using machine learning techniques, we find that the most responsive individuals reduce spending and increase savings by 4.9% (206 USD PPP per month) while their credit card debt remains unchanged. These individuals' marginal responses to the nudge are consistent with our model of coholding for the purpose of self‐ or partner‐control.
