Credit Smoothing

Sean Hundtofte, Arna Olafsson, Michaela Pagel

Research output: Contribution to conferencePaperResearchpeer-review

Abstract

Standard economic theory suggests that high-interest, unsecured, short-term borrowing, e.g., borrowing via credit cards and 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 a typical transitory income shock due to unemployment. Rather, it appears as if individuals smooth their roll-over credit card debt and overdrafts. We first use detailed longitudinal information on debit and credit card transactions, bank account balances, and limits 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 do not bind (as captured by credit limits). This finding is difficult to reconcile with theories of consumption smoothing, which predict a strictly countercyclical demand for credit. On the contrary, the demand for credit does not appear to lean against business cycle fluctuations, leading to greater consumption volatility than what would be observed otherwise.
Original languageEnglish
Publication date2019
Number of pages60
Publication statusPublished - 2019
EventThe 54th Annual Conference of the Western Finance Association. WFA 2019 - Hyatt Regency Huntington Beach, Huntington Beach, United States
Duration: 16 Jun 201919 Jun 2019
Conference number: 54
https://westernfinance.org/conference-2019/

Conference

ConferenceThe 54th Annual Conference of the Western Finance Association. WFA 2019
Number54
LocationHyatt Regency Huntington Beach
CountryUnited States
CityHuntington Beach
Period16/06/201919/06/2019
Internet address

Cite this

Hundtofte, S., Olafsson, A., & Pagel, M. (2019). Credit Smoothing. Paper presented at The 54th Annual Conference of the Western Finance Association. WFA 2019, Huntington Beach, United States.
Hundtofte, Sean ; Olafsson, Arna ; Pagel, Michaela. / Credit Smoothing. Paper presented at The 54th Annual Conference of the Western Finance Association. WFA 2019, Huntington Beach, United States.60 p.
@conference{a8bd9db042dc4111b45dff0feccaee94,
title = "Credit Smoothing",
abstract = "Standard economic theory suggests that high-interest, unsecured, short-term borrowing, e.g., borrowing via credit cards and 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 a typical transitory income shock due to unemployment. Rather, it appears as if individuals smooth their roll-over credit card debt and overdrafts. We first use detailed longitudinal information on debit and credit card transactions, bank account balances, and limits 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 do not bind (as captured by credit limits). This finding is difficult to reconcile with theories of consumption smoothing, which predict a strictly countercyclical demand for credit. On the contrary, the demand for credit does not appear to lean against business cycle fluctuations, leading to greater consumption volatility than what would be observed otherwise.",
author = "Sean Hundtofte and Arna Olafsson and Michaela Pagel",
year = "2019",
language = "English",
note = "null ; Conference date: 16-06-2019 Through 19-06-2019",
url = "https://westernfinance.org/conference-2019/",

}

Hundtofte, S, Olafsson, A & Pagel, M 2019, 'Credit Smoothing' Paper presented at, Huntington Beach, United States, 16/06/2019 - 19/06/2019, .

Credit Smoothing. / Hundtofte, Sean; Olafsson, Arna ; Pagel, Michaela.

2019. Paper presented at The 54th Annual Conference of the Western Finance Association. WFA 2019, Huntington Beach, United States.

Research output: Contribution to conferencePaperResearchpeer-review

TY - CONF

T1 - Credit Smoothing

AU - Hundtofte, Sean

AU - Olafsson, Arna

AU - Pagel, Michaela

PY - 2019

Y1 - 2019

N2 - Standard economic theory suggests that high-interest, unsecured, short-term borrowing, e.g., borrowing via credit cards and 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 a typical transitory income shock due to unemployment. Rather, it appears as if individuals smooth their roll-over credit card debt and overdrafts. We first use detailed longitudinal information on debit and credit card transactions, bank account balances, and limits 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 do not bind (as captured by credit limits). This finding is difficult to reconcile with theories of consumption smoothing, which predict a strictly countercyclical demand for credit. On the contrary, the demand for credit does not appear to lean against business cycle fluctuations, leading to greater consumption volatility than what would be observed otherwise.

AB - Standard economic theory suggests that high-interest, unsecured, short-term borrowing, e.g., borrowing via credit cards and 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 a typical transitory income shock due to unemployment. Rather, it appears as if individuals smooth their roll-over credit card debt and overdrafts. We first use detailed longitudinal information on debit and credit card transactions, bank account balances, and limits 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 do not bind (as captured by credit limits). This finding is difficult to reconcile with theories of consumption smoothing, which predict a strictly countercyclical demand for credit. On the contrary, the demand for credit does not appear to lean against business cycle fluctuations, leading to greater consumption volatility than what would be observed otherwise.

M3 - Paper

ER -

Hundtofte S, Olafsson A, Pagel M. Credit Smoothing. 2019. Paper presented at The 54th Annual Conference of the Western Finance Association. WFA 2019, Huntington Beach, United States.