New Perspectives on Consumer Behavior in Credit and Payments Markets

Article excerpt

At the Federal Reserve Bank of Philadelphia's latest conference on consumer credit and payments, researchers presented the results of the following seven studies on topics including household financial decision-making, the effects of regulation on credit card markets, and the effect on individuals of interactions between credit and labor markets. (1)

STICKING TO YOUR PLAN: HYPERBOLIC DISCOUNTING AND CREDIT CARD DEBT PAYDOWN

Theresa Kuchler, of New York University's Stern School of Business, reported on an empirical study of individuals' success in carrying out plans to reduce their credit card balances. Broadly, Kuchler had two objectives. Her first objective was to find evidence for present-biased behavior, in which consumers make plans to reduce future borrowing but systematically deviate from their plans by acting impatiently in the future. Her second objective was to determine the extent to which individuals are sophisticated about their own behavior, in the sense that they understand that they act in a present-biased way and make borrowing decisions that reflect this understanding.

Kuchler developed a simple model of consumer borrowing behavior that could be used to make predictions about how different types of consumers would behave. She tested her predictions using a remarkably detailed data set from an online financial management service. Individuals use this service to make plans to reduce their credit card balances, although the service doesn't impose penalties if they fail to meet those plans. Individuals provide demographic information--for example, age, income, and education--as well as information about their paycheck receipts and detailed information about their credit card use, bank account behavior, and expenditures. Moderating concerns that the people using a financial planning service are not representative of the broader population, Kuchler explained that according to observable demographic measures, the sample is reasonably similar to the general population.

In the first part of the study, Kuchler sought to measure present bias. Specifically, she measured present bias by the sensitivity of an individual's discretionary expenditures--restaurant and entertainment expenditures--to the receipt of a paycheck. Intuitively, a larger expenditure on discretionary items as soon as a paycheck arrives is consistent with impatient behavior, especially when this expenditure conflicts with a prior plan to use the income to reduce credit card balances. She finds that many consumers' discretionary expenditures are very sensitive to the receipt of a paycheck, a finding consistent with present bias. (Kuchler explained that such behavior was also consistent with other explanations, a matter she addressed later.)

Kuchler argued that present-biased individuals might, nonetheless, be fully rational and aware of their behavior (thus being sophisticated). Alternatively, they might be naive, and simply not understand that in the future they are likely to act in a way that frustrates their current plans. Her model offers predictions about how a present-biased but sophisticated individual would behave differently from one who was also present-biased but naive. Specifically, the model predicts that very impatient but sophisticated individuals will typically pay down less of their debt than those who are also sophisticated but less impatient. Intuitively, a sophisticated, impatient individual reasons that, "I know in the future I am going to consume more than my current plan for future consumption. Therefore, I can achieve a smoother consumption path if I consume more today, which will, in turn, reduce future consumption." Naive individuals don't reason this way because they don't understand that they will act in a way that frustrates their plans for the future. Accordingly, the level of impatience will not affect the extent to which they pay down their debt.

Kuchler's empirical results confirmed her strategy for identifying individual degrees of impatience and also her distinction between sophisticated and naive individuals. …