Telyukova_tw - A Model of Money and Credit with Application to the Credit Card Debt Puzzle Irina A Telyukova University of California San Diego

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
A Model of Money and Credit, with Application to the Credit Card Debt Puzzle Irina A. Telyukova University of California — San Diego Randall Wright University of Pennsylvania August 27, 2007 Abstract Many individuals simultaneously have signi f cant credit card debt and money in the bank. The credit card debt puzzle is: given high interest rates on credit cards and low rates on bank accounts, why not pay down debt? While some economists go to elaborate lengths to explain this, we argue it is a special case of the rate of return dominance puzzle from monetary economics. We extend standard monetary theory to incorporate consumer debt, which is interesting in its own right since developing models where money and credit coexist is a long-standing challenge. Our model is quite tractable — e.g., it readily yields nice existence and characterization results — and helps puts into context recent discussions of consumer debt. We thank Neil Wallace, Ed Nosal, and participants of seminars at Penn, UC-Riverside, UQAM, Essex, the Federal Reserve Banks of Cleveland, Philadelphia and New York, and the 2006 SED meetings in Vancouver for feedback. We thank the National Science Foundation and the Jacob K. Javitz Graduate Fellowship Fund for research support. The usual disclaimer applies. 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
1I n t r o d u c t i o n A large number of households simultaneously have a signi f cant amount of credit card debt and a signi f cant amount of low-interest liquid assets, such as money in their checking accounts. There are many ways to measure this, and we discuss some of the empirical issues in more detail in Section 4.2, but for now we o f er these simple summary statistics from Telyukova (2006): 27% of U.S. households in 2001 had credit card debt and liquid assets both in excess of $500; and the median household in this group revolved around $3,800 on their credit cards even though they had $3,000 in the bank. The so-called credit card debt puzzle is this: given 14% interest rates on credit cards, and 1 or 2% on bank accounts, why not pay down debt? According to Gross and Souleles (2001), “Such behavior is puzzling, apparently inconsistent with no-arbitrage and thus inconsistent with any conventional model.” Some economists have gone to elaborate lengths recently to explain such phenomena. For example, some assume that consumers cannot control themselves (Laibson et al. 2000); others assume that they cannot control their spouses (Bertaut and Haliassos 2002; Haliassos and Reiter 2003); and others hypothesize that such households are typically on the verge of bankruptcy (Lehnert and Maki 2001). These ideas are certainly interesting, may contain elements of truth, andw i l lbed iscussedfurtherbe low ,butfromtheoutsetwewan ttopo in toutthatthecred it card debt puzzle is actually not a new observation. Rather, it is another manifestation of the venerable rate of return dominance puzzle from monetary economics. Hence, insights may be gained by using models and ideas from monetary theory, and in particular, by taking seriously the notion of liquidity.
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 11/30/2010 for the course ECON 120A 1684210 taught by Professor Elliot during the Spring '10 term at UCSD.

Page1 / 35

Telyukova_tw - A Model of Money and Credit with Application to the Credit Card Debt Puzzle Irina A Telyukova University of California San Diego

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online