Untangling the Effects of Credit Cards on Money Demand: Convenience Usage vs. Borrowing

Article excerpt


In the early 1990s, the popular press painted a picture of the credit card industry as a wolf pack devouring the innocent sheep who were borrowers. And it is true that from 1983 to 1995 average consumer revolving credit rose from $291 1983 dollars to $812 1983 dollars based on household data from the 1983 and 1995 Surveys of Consumer Finances. This is a 179 percent real increase in borrowing. This large level of indebtedness was presented as a problem of epidemic proportions in the media. Yet little empirical research has been done on the credit card as a method of borrowing.

Understanding why and how people use credit cards is of interest. Are they using credit cards merely for the convenience of paying out all cash at once and enjoying the float that is created in the meantime? Or are they using credit cards as an easy form of borrowing (in the sense that once a consumer holds a credit card he or she does not have to apply for a small loan but may obtain it automatically by charging purchases)? By looking at credit cards and the effect that they have on different measures of individual money demand, one can begin to untangle the different uses of the credit card. This aids in understanding the buying and borrowing patterns of the consumer.

Some research has been done on the credit card as an alternate transaction medium. The most notable is a 1995 Duca and Whitesell study. It finds that credit card ownership and checking account deposit balances, a proxy for money demand, are negatively related, while there is a positive relationship between savings accounts and credit card ownership. These results are consistent with theories of money demand that include credit cards as alternate transaction media.

Work by Yoo (1997 and 1998) suggests that a very small number of card-holding households is responsible for the large amount of consumer revolving debt. Thus, the question remains: is credit card debt (and therefore borrowing) what is driving the negative result found between credit card ownership and checking account deposit balances? Without looking explicitly at borrowing, there is no way to know if any given credit card-holding household is borrowing on the card or using it as an alternate transaction medium. Given the large increases observed in revolving credit in recent years, at least some of the households are borrowing. Because this borrowing is so large, is it large enough to drive the results that others have suggested point to convenience usage of the credit card?

No work has been done that incorporates both the credit card's use as a method of borrowing and as an alternate transaction medium. This study attempts to address this issue. Households have the option of using their credit card because it is more convenient and perhaps financially advantageous to use a credit card instead of money. They may also choose to borrow on the credit card in the same month. Because households are not required to sign contracts stating that they will either only borrow on the card or always pay the card off at the end of each month, (1) empirically it may be difficult to see the difference between the two because both the convenience usage of the credit card and borrowing on the credit card may cause a negative relationship between checking balances and owning a credit card.

I extend the previous studies by adding into the empirical framework a theory of credit card usage introduced by Brito and Hartley (1995). By also looking at the impact that the volume of a credit card revolving balance has on a transactions account, the effects of convenience usage versus borrowing on the card can begin to be untangled. My results suggest that part of the negative effect of being a credit card-holder on money demand is due to borrowing. This is overlooked in the previous studies.

Literature Review

Credit cards are approached two ways in the theoretical literature. …