Household Need for Liquidity and the Credit Card Debt Puzzle

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Abstract
In the 2001 U.S. Survey of Consumer Finances, 27% of households report simultaneously revolving significant credit card debt and holding sizeable amounts of low-return liquid assets; this is known as the “credit card debt puzzle”. In this article, I quantitatively evaluate the role of liquidity demand in accounting for this puzzle: households that accumulate credit card debt may not pay it off using their money in the bank, because they anticipate needing that money in situations where credit cards cannot be used. I characterize the puzzle in survey data, and calibrate a dynamic stochastic heterogeneous-agent model of household portfolio choice, where consumer credit and liquidity coexist as means of consumption and saving, where households consume a cash good and a credit good, and where cash consumption is subject to uncertainty. The model accounts for between 44% and 56% of the households in the data who hold consumer debt and liquidity simultaneously, and for 100% of the liquidity held by a median such household. Under reasonable calibration alternatives, the model can capture the entire puzzle group size as well. One-half of money demand in the model is precautionary.