Consumer Credit from Theory to Practice: Financial Responses to a Precarious Economy

Abstract

Consumer credit, and credit cards in particular, are one of the few financial resources in the United States that can be easily and quickly accessed to help households make ends meet. Significant attention has been given to the macro-level factors contributing to rising consumer debt since the 1970s; however, few comprehensive theories have been developed to explain the micro-level factors contributing to an individual’s or a household’s use and accumulation of debt, and the available micro-level theory is at times in tension with empirical evidence. This study examines the existing theories surrounding individual use and accumulation of debt to provide a thorough understanding of how individuals and households use credit card debt, and how reliance on credit card debt compares to other components of the household's balance sheet. I find, in contrast to what is often predicted in prior work, that households do not increase credit card debt following job loss and instead rely on other resources, such as borrowing from social networks, decreasing secured debts, and spending or selling assets. In response to less severe income reductions, such as a general negative income shock, households in fact decrease credit card debt, and typically only increase credit card debt following a substantial increase in income. Given how these results cast doubt on credit card debt arising from negative income shocks, I next turn to additional research from fields such as behavioral economics that highlight individual attributes – low financial literacy, high risk tolerance, present bias, and impatience – as predictive of credit card reliance. When testing the predictive power of these factors, I find that structural factors, primarily rising income, are substantially more predictive of credit card debt use and level relative to the behavioral attributes. Furthermore, the role of behavioral attributes may be overstated in analyses that focus on a single attribute, without controlling for other important factors at the individual level. To help interpret how structural factors, such as income, are the key determinants of credit card behaviors, I discuss how a debt-aversion framework that incorporates the social meaning of money may more naturally explain the observed phenomena.