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What Credit Card Puzzle? Precaution, Variable Debt Limits, and What We Can Learn from the Small Debts of Poor People (Fulford S.)

Bank Lending Household Strategies

Abstract Many people in the United States have both a revolving credit card balance on which they pay a high rate of interest, and have liquid checking or savings accounts on which they earn little interest. Why would so many people throw so much money away? This paper shows that it may not be much of a puzzle: if credit limits may change unexpectedly, that creates a reason for people to hold on to cash or savings as consumption insurance against the times when they have a high benefit from consumption but cannot borrow. I show that this approach can explain the credit card puzzle with low probabilities of losing access to credit for a wide range of preferences. The approach in this paper offers a novel channel for how financial uncertainty can affect real decisions: if the probability of losing access to credit increases, consumers will increase saving and decrease consumption to add to their insurance, even without "real" shocks to income.
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Libref/ Fulford S. (2010) "What Credit Card Puzzle? Precaution, Variable Debt Limits, and What We Can Learn from the Small Debts of Poor People", Boston College Working Papers in Economics No. 754, pp. 1 - 45
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