Estimating Discount Functions with Consumption Choices over the Lifecycle

We estimate β-δ time preferences and relative risk aversion (RRA) using a lifecycle model including stochastic income, liquid and illiquid assets, credit cards, dependents, Social Security, mortality, and bequests. Preference parameters are identified by cross-tabulating four lifecycle age intervals and four balance sheet moments: the proportion of households carrying (i.e., revolving) credit card debt, average carried credit card debt, average net wealth among households carrying credit card debt, and average net wealth among households not carrying credit card debt. The sixteen moments are approximately matched by (MSM) parameter estimates β = 0:50, δ = 0:99, and RRA = 1:3.

Present-Biased Preferences and Credit Card Borrowing

Some individuals borrow extensively on their credit cards. This paper tests whether present-biased time preferences correlate with credit card borrowing. In a field study, we elicit individual time preferences with incentivized choice experiments, and match resulting time preference measures to individual credit reports and annual tax returns. The results indicate that present-biased individuals are more likely to have credit card debt, and to have significantly higher amounts of credit card debt, controlling for disposable income, other socio-demographics, and credit constraints. (JEL D12, D14, D91)

The Effect of Credit on Spending Decisions: The Role of the Credit Limit and Credibility

The objective of the present research is to study consumer decisions to utilize a line of credit. The life-cycle hypothesis from economics argues that consumers should intertemporally reallocate their incomes over their life stream to maximize lifetime utility. One form of intertemporal allocation is to use past income (in the form of savings) in the future. A second form is the use of future income in the present. This can only be done if consumers have access to a temporary pool of money that they can draw from and replenish in the future—a function performed by consumer credit. However, our research reinforces prior findings that consumers are unable to correctly value their future incomes, and that they lack the cognitive capability to solve the intertemporal optimization problem required by the life-cycle hypothesis. Instead, we argue that consumers use information such as the credit limit as a signal of their future earnings potential. Specifically, if consumers have access to large amounts of credit, they are likely to infer that their lifetime income will be high and hence their willingness to use credit (and their spending) will also be high. Conversely, consumers who are granted lower amounts of credit are likely to infer that their lifetime income will be low and hence their spending will be lower. However, based on research in the area of consumer skepticism and inference making, we also argue for a moderating role of the credibility associated with the credit limit. Specifically, we argue that the above effect of credit availability would be particularly strong for consumers who believe that the credit limit credibly signals their future earnings potential (i.e., a naïve consumer who has limited experience with consumer credit). However, as consumers gain experience with credit, they start discounting credit availability as a predictor of their future and start questioning the validity of the process used to set the credit limit. Hence, with experience the effect of credit limit on the willingness to use credit should be attenuated. We test these predictions in five separate studies. In the first experimental study, we manipulate credit limit and credibility and pose subjects with a hypothetical purchase opportunity. Consistent with our prediction, credit limit impacted the propensity to spend, but only when the credibility was high. In the second experimental study, we replicate these findings even when subjects were given information about their expected future salaries, and also show that the credit limit influences their expectation of future earnings potential. In the third study, we show that the mere availability (and increase) of current liquidity cannot explain our findings. In the fourth study, we conduct a survey of consumers in which we measure a number of demographic characteristics and also ask them for their propensity to spend in a given purchase situation. In the fifth study we use the Survey of Consumer Finances (SCF) dataset, a triennial survey of U.S. families that is designed to provide detailed information on the use of financial services, spending behaviors, and selected demographic characteristics. Results from both studies 4 and 5 provide further support for our proposed framework—credit limits influence spending to a greater extent for consumers with lower credibility: younger consumers and less-educated consumers. Across all studies we achieved triangulation by using a variety of approaches (surveys and experiments), subjects types (young students and older consumers), nature of predictor variables (manipulated and measured), dependent measures (purchase likelihood, credit card balance, new charges), and methods of analysis (ANOVA and regression), and consistently found that increasing credit limits on a credit card increases spending, especially when the credibility of the limit is high. This paper joins a growing body of literature in marketing and behavioral decision theory that goes beyond the traditional domains of inquiry (e.g., product choice, effects of marketing mix variables) and focuses on consumer decisions relating to the appropriate use of income to finance consumption. Our framework differs from prior research on the effect of payment mechanisms on spending in two significant ways. First, we are interested in the effects of the availability of credit on spending, and not necessarily in the effect of the transaction format that is associated with each payment mechanism. Second, while prior research has studied the point-of-purchase and historic (i.e., prepurchase) effects of credit, the present research is concerned with the availability of credit in the future. Specifically, our framework is invariant to the current and prior usage of credit by the consumer.

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.

When Motivation is against Debtors' Best Interest: The Illusion of Goal Progress in Credit Card Debt Repayment

The authors explore the illusion of goal progress by consumers who own multiple credit cards and pay off their debt balances to facilitate the achievement of their subgoal rather than the superordinate goal of being debt-free. The first experiment shows that debtors use their savings toward the credit card debt they can pay off entirely or substantially, even if it is associated with the smallest balance and the lowest annual percentage rate rather than toward the debt with the highest annual percentage rate. The second experiment reveals that when the income available to pay down the debt is in the form of effortless money (i.e., windfall or reward money) as opposed to hard-earned savings, the tendency to allocate money toward the smallest credit card debt is exacerbated. However, people tend to pay their debt more rationally when the number of debt accounts increases. Finally, the third experiment shows that credit card debt repayment decisions depend on the nature of the debt (hedonic vs. utilitarian) and the timing of consumption benefits (past vs. future). The article concludes with a discussion of managerial and public policy implications.

Credit Card Debt Puzzles and Debt Revolvers for Self Control

Abstract Most US credit card holders revolve high-interest debt, often with substantial liquid and retirement assets. We model separation of accounting from shopping allowed by credit cards, in a rational, dynamic game. When the shopper is more impatient than the accountant, selling assets to repay debt is not necessarily optimal, as the shopper can restore debt. Modest relative impatience generates asset-debt co-existence and target utilization rates, matching incidence and median assets of debt revolvers with substantial assets. Empirical evidence is consistent with a role for spending control considerations, after allowing for standard determinants of credit card debt.

Household Debt: Facts, Puzzles, Theories, and Policies

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.

Timing to the Statement: Understanding Fluctuations in Consumer Credit Use

We show that consumers spend 15% more per day in the first week following the receipt of a credit card statement than in the days just prior to the statement. This increase in spending includes both an increase in the likelihood that they use the credit card in the first weeks following their statement and an increase in transaction amount on days they use the credit card. In contrast to the effect on credit card spending, debit card spending is unaffected by credit card statement issuance, suggesting that consumers are not simply switching among modes of payment. Our estimates are based on exogenous variation from bank-assigned statement dates. We propose and test several alternative explanations to this spending puzzle: optimization of the free float, salience effect of the credit card statement, mental accounting, liquidity constraints, and automatic payments. We find that the consumers most apt to spend early in the credit card cycle tend to be those who do not revolve balances and are not close to their credit limit. Thus, this paper documents a puzzle with mixed support for several alternative explanations. This paper was accepted by David Simchi-Levi, finance.

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.

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 Credit Card Debt Puzzle: The Role of Preferences, Credit Access Risk, and Financial Literacy

Abstract. We use the 1979 National Longitudinal Survey of Youth to revisit what is termed the credit card debt puzzle: why consumers simultaneously co-hold high-interest credit card debt and low-interest assets that could be used to pay down this debt. Relative to individuals with no credit card debt but positive liquid assets, borrower-savers have very different perceptions of future credit access risk and use credit cards for precautionary motives. Moreover, changing perceptions about credit access risk are essential for predicting transitions among the two groups. Preferences and the composition of financial portfolios also play a role in these transitions.

The Impact of Payment Frequency on Consumer Spending and Subjective Wealth Perceptions

Abstract Payment frequency is a fundamental yet underexplored feature of consumers’ finances. As higher payment frequencies are becoming more prevalent, consumers are receiving more frequent yet smaller paychecks. An analysis of income and expenditure data of over 30,000 consumers from a financial services provider demonstrates a naturally occurring relationship between higher payment frequencies and increased spending. A series of lab studies support this finding, providing causal evidence that higher (vs. lower) payment frequencies increase spending. The effect of payment frequency on spending is driven by changes in consumers’ subjective wealth perceptions. Specifically, higher payment frequencies reduce consumers’ uncertainty in predicting whether they will have enough resources throughout a period, increasing their subjective wealth perceptions. As such, situational factors that reduce prediction uncertainty for those paid less frequently (e.g., the timing of consumers’ expenses, income levels) moderate the impact of payment frequency. The effects of payment frequency on subjective wealth and spending can occur even when objective wealth favors those with lower payment frequencies. More broadly, the current work underscores a need to understand how timing variations in consumers’ income impact their perceptions, behaviors, and general well-being.

Consumption Response to Credit Expansions: Evidence from Experimental Assignment of 45,307 Credit Lines

In a field experiment that constructs a randomized credit limit shock, participants borrow to spend 11 cents on the dollar in the first quarter and 28 cents by the third year. Effects extend to those far from the limit, those who had the new limits as available credit, and those with a liquid asset buffer. In the short-run, flexible and installment contracts are used in tandem, with unconstrained using installments more. Long-run borrowing is predominantly using installments. Near limits, participants borrow when credit expands but save out of constraints when limits are tight. Findings support a buffer-stock interpretation emphasizing precautionary saving.

Does Saving Cause Borrowing? Implications for the Co-Holding Puzzle

Using an experiment in which 3.1 million bank customers were encouraged to save, we explore the mechanisms behind co-holding liquid savings and credit card debt. Theoretically, we first show that the joint responses of spending, saving, and borrowing to the nudge differ for different economic models of co-holding. Using machine learning techniques, we then find that the most responsive individuals reduce spending and increase their savings by 4.9% (206 USD PPP per month) while their credit card debt remains unchanged. For them, the marginal responses to the nudge are consistent with our model of co-holding for the purpose of self- or partner control.

Revolving versus Convenience Use of Credit Cards: Evidence from U.S. Credit Bureau Data

Credit card payments and revolving debt are important for consumer theory but a key data source — credit bureau records — does not distinguish between current charges and revolving debt from the previous month. We develop a theory-based econometric methodology informed by survey evidence to estimate the likelihood a consumer is revolving each quarter. We validate our approach using a new survey linked to credit bureau data. For likely revolvers: (1) 100 percent of an increase in credit becomes an increase in debt eventually; (2) credit limit changes are half as salient as debt changes; and (3) revolving status is extremely persistent.

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