Credit Cards and Money-Demand: A Cross-Sectional Study
Journal article by John V. Duca, William C. Whitesell; Journal of Money, Credit & Banking, Vol. 27, 1995
Journal Article Excerpt
Credit cards and money-demand: a cross-sectional study. by John V. Duca , William C. Whitesell Since the 1960s, credit card use in the United States has increased dramatically, as reflected in debt levels and ownership rates.(1) Nevertheless, there have been few empirical studies of credit card effects on money demand. Using the 1970 Survey of Consumer Finances (SCF), Mandell (1972) found that families with credit cards had smaller demand deposit balances than those without, but that the difference was statistically insignificant. Using data from one bank, White (1976) found that credit cards significantly reduced household demand deposits. There are problems, however, with these studies. First, when they and other studies (for example, Feige 1964, 1974 and Lee 1964) were done, existing techniques could not handle the self-selection bias that arises when only deposit owners are sampled and the potential simultaneity bias if credit card ownership depends on money demand. Second, neither study controlled for the impact of wealth or assets on money. Third, White's data were not based on the total holdings of demand deposits of households at all depositories. Finally, White's findings may be skewed toward higher-income households, since he had no data on balances at thrift institutions, where low-income families tended to have deposits. Our study avoids these problems by using newer empirical techniques along with data on household balances at all depositories and household assets. To avoid selectivity and simultaneity biases, a multistage estimation procedure is used. In the first step, probit models of deposit account and credit card ownership are estimated. In the second stage, constructed variables from the account probits are used to correct money demand regressions for selectivity bias, and the estimated probability of card ownership is used to instrument for card ownership. The study makes three other contributions. First, previously used data sets (for example, Feige 1964, 1974 and Lee 1964) did not have the extensive demographic and preference information of the 1983 SCF. Second, our study conducts cross-sectional tests of income and assets as scale variables. Third, this paper uses cross-sectional data after deposit deregulation and a period of dramatic growth of credit cards. This study is organized as follows. Section 1 begins with a brief theoretical discussion. The second section presents the estimation method and section 3 discusses the data. Results are reviewed in section 4, and the final section presents conclusions. 1. CREDIT CARDS AND MONEY BALANCES IN THEORY The empirical analysis could be related to a framework in which households maximize the utility of consumption, subject to using a medium of exchange in any transaction. Payment media are currency, checks, or credit cards, each having different transaction costs across purchases.(2) Transaction costs are also incurred in shifting among money and other financial assets (for example, bonds and stocks). The costs and benefits of account or credit card ownership and optimal balances depend on transaction costs, interest rates, and institutional restrictions. Liquidity constraints may also affect who owns credit cards. The decision to own an account or card involves comparing the discounted net benefit of use with any fixed costs. As noted by Marcus (1960) and White (1976), the effect of credit cards on transaction balances may be ambiguous. Card ownership could be associated with smaller checking account balances because (1) a card owner probably holds lower precautionary money balances since a card can be used for emergency payments; (2) while awaiting the credit card bill, funds could be held in an asset earning higher returns than a checking account; and (3) cardholders may synchronize payments so that the card bill is paid shortly after receiving a paycheck. By contrast, card ownership could be positively related to checking balances because (1) there may be fewer currency withdrawals from checking accounts if cards substitute for currency; (2) when cards substitute for checks, checking balances may stay idle longer if it is too costly to shift into higher-earning assets; and (3) card ownership may reveal a higher propensity to consume, an aspect that is ignored by the literature but is relevant for cross-section studies with income or wealth proxying for spending.The propensity-to-consume effect can be shown by assuming that credit cards offer a net variable benefit of b per dollar over checks for p percent of spending at merchants who accept cards. In a single-period framework, a household obtains a card if the fixed cost of owning it, q, is less than the benefit, bpcY, where c is the propensity to consume out of permanent income, Y. Suppose income is constant ... |
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