A Debt Puzzle

71 Pages Posted: 1 Sep 2000 Last revised: 14 Jul 2021

See all articles by David Laibson

David Laibson

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Andrea Repetto

University of Chile - Engineering Department

Jeremy Tobacman

Alfred Lerner College of Business and Economics, University of Delaware

Date Written: September 2000

Abstract

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 life cycle 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 can not 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 resolution to this puzzle: hyperbolic time preferences. Simulated hyperbolic consumers borrow actively in the revolving credit card market and accumulate relatively large stocks of illiquid wealth, matching observed data.

Suggested Citation

Laibson, David I. and Repetto, Andrea and Tobacman, Jeremy, A Debt Puzzle (September 2000). NBER Working Paper No. w7879, Available at SSRN: https://ssrn.com/abstract=240747

David I. Laibson (Contact Author)

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Andrea Repetto

University of Chile - Engineering Department ( email )

Republica 701 Santiago
Chile

Jeremy Tobacman

Alfred Lerner College of Business and Economics, University of Delaware ( email )

Newark, DE 19716
United States

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