Credit Smoothing

Sean Hundtofte, Arna Olafsson, Michaela Pagel

Research output: Contribution to conferencePaperResearchpeer-review

Abstract

Standard economic theory says that unsecured, high-interest, short-term loans – such as borrowing via credit cards and bank overdraft facilities – helps individuals smooth consumption in the event of transitory income shocks. This paper shows that—on average—individuals do not use such borrowing to smooth consumption when they experience the typical transitory income shock of unemployment. Rather, it appears as if individuals smooth their roll-over credit card debts and overdrafts. We first use detailed longitudinal information on debit and credit card transactions, account balances, and credit lines from a financial aggregator in Iceland to document that unemployment does not induce a borrowing response at the individual level. We then replicate this finding in a representative sample of U.S. credit card holders, instrumenting local changes in employment using a Bartik (1991)-style instrument. The absence of a borrowing response occurs even when credit supply is ample and liquidity constraints, captured by credit limits, do not bind. This finding stands in contrast to the prediction of strictly countercyclical demand for credit by theories of consumption smoothing. On the contrary, demand for credit appears to be procyclical, which may deepen business cycle fluctuations.
Original languageEnglish
Publication date2019
Number of pages62
Publication statusPublished - 2019
EventConsumer Finance: Micro and Macro Approaches - Becker Friedman Institute, University of Chicago, Chicago, United States
Duration: 10 May 201911 May 2019
https://bfi.uchicago.edu/event/consumer-finance-micro-and-macro-approaches/

Conference

ConferenceConsumer Finance: Micro and Macro Approaches
LocationBecker Friedman Institute, University of Chicago
Country/TerritoryUnited States
CityChicago
Period10/05/201911/05/2019
Internet address

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