A Debt Puzzle

Over 60% of US households with credit cards are currently borrowing – i.e., paying interest – on those cards. We attempt to reconcile the high rate of credit card borrowing with observed levels of lifecycle wealth accumulation. We simulate a lifecycle model with five properties that create demand for credit card borrowing. First, the calibrated labor income path slopes upward early in life. Second, income has transitory shocks. Third, consumers invest actively in an illiquid asset, which is sufficiently illiquid that it cannot be used to smooth transitory income shocks. Fourth, consumers may declare bankruptcy, reducing the effective cost of credit card borrowing. Fifth, households have relatively more dependents early in the life-cycle. Our calibrated model predicts that 20% of the population will borrow on their credit card at any point in time, far less than the observed rate of over 60%. We identify a partial resolution to this puzzle: dynamically inconsistent time preferences of the type proposed by Phelps and Pollak (1968). Simulated consumers with such preferences borrow actively in the revolving credit card market and accumulate relatively large stocks of illiquid wealth, matching observed data. JEL classification: D91 (Intertemporal Consumer Choice; Lifecycle Models and Saving), E21 (Consumption; Saving) ∗We have benefited from the insights of Daron Acemoglu, Alberto Alesina, Orazio Attanasio, Robert Barro, Martin Browning, John Campbell, Christopher Carroll, José de Gregorio, Eduardo Engel, Benjamin Friedman, Edward Glaeser, Cristóbal Huneeus, Greg Mankiw, Julio Rotemberg, Andrei Shleifer, Nicholas Souleles, Richard Zeckhauser, and Steve Zeldes. Marios Angeletos, Eddie Nikolova, and Stephen Weinberg provided excellent research assistance. Laibson acknowledges financial support from the National Science Foundation (SBR-9510985), the National Institute on Aging (R01-AG-16605), the MacArthur Foundation and the Olin Foundation; Repetto from DID-Universidad de Chile, FONDECYT (1990004), and Fundación Andes; and Tobacman, from the National Science Foundation.