Household Need for Liquidity and the Credit Card Debt Puzzle

Abstract

In the 2001 U.S. Survey of Consumer Finances (SCF), 27% of households report simultaneously revolving signicant credit card debt and holding sizeable amounts of low-return liquid assets; this is known as the \credit card debt puzzle. In this paper, I quantitatively evaluate the role of liquidity demand in accounting for this puzzle: households that accumulate credit card debt may not pay it o using their money in the bank, because they anticipate needing that money in situations where credit cards cannot be used. I characterize the puzzle in survey data, and calibrate a dynamic stochastic heterogeneous-agent model of household portfolio choice, where consumer credit and liquidity coexist as means of consumption and saving, where households consume a cash good and a credit good, and where cash consumption is subject to uncertainty. The model accounts for between 44% and 56% of the households in the data who hold consumer debt and liquidity simultaneously, and for 100% of the liquidity held by a median such household. Under reasonable calibration alternatives, the model can capture the entire puzzle group size as well. One-half of money demand in the model is precautionary.