The Impact of Liquidity on Household Balance Sheets: Micro Responses to a Credit Card Supply Shock

Despite growing evidence that many US households are liquidity constrained, there remains little consensus on the quantitative importance or nature of these constraints. This paper develops a new type of evidence on the impacts of consumer credit markets on behavior by examining household-level responses to an exogenous liquidity shock. A United States Supreme Court decision effectively deregulated bank credit card interest rates in December 1978, and I find that consumers from states with binding usury ceilings before the decision became more likely to hold bank cards after the decision, relative to their counterparts in unaffected states. The marginal cardholders appear to have characteristics widely associated with credit constraints, and to borrow frequently on their new cards. Yet there is little evidence that these cardholders exploit their newfound liquidity by shifting into higher-yielding, less liquid, or riskier assets. This finding is at odds with standard models of liquidity constraints, and motivates consideration of alternative explanations for the widely observed sensitivity of consumers to liquidity. * [email protected]; tel: 212-720-1204. I am particularly grateful to Daron Acemoglu and Jon Gruber for their guidance. The author also thanks Daniel Bennett and Kurt Johnson for excellent research assistance, and Adam Ashcraft, Ricardo Caballero, Kathleen Johnson, Jim Poterba, Phil Strahan, and participants in the MIT macro and public finance lunches and the 2003 AEA Meetings for helpful comments. The views expressed do not necessarily represent those of the Federal Reserve Bank of New York or of the Federal Reserve System.