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.
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