The Demand for Credit Cards: Evidence from the Survey of Consumer Finances

I. INTRODUCTION The credit card market has expanded rapidly over the past 20 years. In 1983, 65% of households held at least one card; by 1998, about 74% did so. The size of real balances on these cards more than tripled in this period. Analysts have proposed a number of explanations for the increase, but untangling the main causes is complicated by the unique nature of the credit card financial product. An individual who obtains a credit card has obtained the right to borrow a certain amount, called the limit, with no questions asked, under predetermined payback rules. Thus credit cards involve both assets and liabilities. The available limits are best thought of as assets, which can be used by a consumer to hedge against future income shortfalls or just to facilitate paying for goods and thereby reducing the need to carry cash. The asset and limit components of credit cards makes them similar to financial instruments. For example, the asset component is essentially an option, a subject that has been studied extensively in the corporate finance literature. The seminal work is Black and Scholes (1973), who developed a method for valuing an option. Washam and Davis (1998) extend this method to the problem of valuing the liquidity of credit resources. This body of literature suggests that for some people, a credit card can be viewed as a source of liquid funds for business purposes. Moreover, once a credit card is used, it becomes a debt liability. In effect, these are loans that the user has taken on to cover an income shortfall or simply to make a purchase for which borrowing makes sense. Again, a corporate equivalent would be line-of-credit borrowing; see Myers (1989), or Miller et al. (1998) for an introduction. These similarities raise the question of what sort of sample one should analyze for a study of consumer use of credit cards. In all likelihood, many average consumers who use credit cards are actually business entrepreneurs who use the cards to finance small business. Considering that wealth is an important element of any study of credit cards, one faces the further problem that small business wealth is hard to measure accurately. Some research (Lindh and Ohlsson 1998) suggests that access to liquid credit, such as credit cards, can make the difference between becoming self-employed or not. Dunn and Holtz-Eakin (2000) argue that family financial capital can ease the transition to self-employment; although they do not discuss credit availability in their study, their results are strong evidence that credit cards would also ease that transition. Other studies that focus on the role of liquid credit and entrepreneurial activity include Meyer (1990), Blanchflower and Oswald (1998), Cox and Japelli (1990), and Evans and Jovanovich (1989). Our focus here is not on the use of credit cards as a business financing tool, however, it is apparent from this literature that business finance certainly plays a powerful role in determining the use of credit cards by some owners. The research suggests that entrepreneurs would be more likely to be using credit cards for financing business rather than for consumer purposes. For this reason, it is important to separate the self-employed from the non-self-employed in our sample. Looking specifically at consumers, the unusual nature of the credit card financial product raises interesting questions for empirical researchers who hope, as we do, to provide some estimates of the responsiveness of the credit card demand to standard price and income effects. The object of this article is to raise these questions and then answer some of them, estimating regression models using data from the Survey of Consumer Finances (SCF). Specifically, we make two empirical approaches. First, we model credit card demand as a two-stage process, with a consumer obtaining limits in the first stage and then borrowing some fraction of those limits in the second. …