Household Need for Liquidity and the Credit Card Debt Puzzle

In the 2001 U.S. Survey of Consumer Finances (SCF), 27% of households report simultaneously revolving significant costly credit card debt and holding sizable amounts of low-return liquid assets; this is known as the "credit card debt puzzle". In this paper, I quantitatively evaluate the role of predictable and precautionary 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 expect to use that money in situations where credit cards cannot be used. Using both aggregate and survey data (SCF and CEX), I characterize the puzzle and document support in the data for the liquidity hypothesis. I then develop a dynamic heterogeneous-agent model of household portfolio choice, where households are subject to uninsurable income and preference uncertainty, and consumer credit and liquidity coexist as means of consumption and saving/borrowing. The calibrated 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 household in the puzzle group. I show that under reasonable calibration alternatives, the model can capture the entire puzzle group size as well. I also assess the quantitative contribution of each type of idiosyncratic risk and find that about one-half of the liquidity demand in the model is precautionary. The calibration also yields novel measurements of important parameters of preferences and idiosyncratic risk