Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Credit Access, Labor Supply, and Consumer Welfare

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Credit Access, Labor Supply, and Consumer Welfare

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Recent work has argued that U.S. households have seen a systematic improvement in their ability to borrow against future labor income.1 First, Narajabad (2007) points out that the "extensive" margin of credit has changed; he calculates that in 1989, 56 percent of households held a credit card, while 29 percent were actively "revolving" debt (i.e., keeping positive balances after the most recent payment to lenders). By 2004, these measures had risen to 72 and 40 percent, respectively. The availability of such credit has been accompanied by its use, suggesting that households are genuinely less constrained at present than they were in the past. Using Survey of Consumer Finances (SCF) data, Narajabad (2007) shows that average debts among those paying interest on credit card debts nearly doubled from 1989 to 2004, jumping from roughly $1,800 per cardholder to $3,300 (in 1989 dollars). When aggregated, these changes are reflected in the striking findings of Krueger and Perri (2006), who show that the ratio of unsecured debt to disposable income quadrupled from 2 to 9 percent over the period 1980-2001. Parker (2000) and Iacoviello (forthcoming) provide further details on the increase in household indebtedness. Lastly, and most sensationally, recent events in mortgage markets also suggest that there has been a sharp expansion in credit availability. Notably, both the rapid growth of the aggregate homeownership rate in the late 1990s and the recently high default rates on some types of mortgages suggest that the ability to take highly "leveraged" positions in residential real estate has indeed increased.

The large changes in borrowing summarized above appear to be consistent with improved information held by lenders at the time of credit extension (see, for example, Athreya, Tam, and Young 2007), as well as a secular decline in the cost of maintaining and issuing credit contracts (see, for example, Athreya 2004). As an empirical matter, Furletti demonstrates strikingly that in 2002, the interest rate conferred on those with the highest credit score was eight percentage-points lower than those with the lowest credit scores. In 1990, by comparison, this premium was essentially nonexistent. Relatedly, Edelberg (2006) notes that there has been a substantial increase in the sensitivity of most loan interest rates to forecasts of default risk. Improvements in the ability of lenders to screen borrowers will have allowed many to access credit, instead of being denied outright. In sum, both theory and evidence strongly suggest that households may now be better able than ever before to use credit markets to smooth consumption.

A direct consequence of better access to credit is allowing households to borrow to finance consumption. However, a perhaps equally important effect, and one that has not received systematic attention thus far, is that better credit access will allow households to more effectively align work effort with productivity. That is, when temporarily unproductive, a household can use credit in lieu of labor effort, and instead work more when it is relatively productive. At a quantitative level, varying labor effort in response to productivity may well be an important channel for consumption smoothing; it has also long been known that idiosyncratic shocks to labor productivity dwarf business cycle-related risks facing U.S. households. It is also agreed that these shocks are, in general, poorly insured.2

The use of labor effort itself as a smoothing device, even in the absence of credit markets, has only recently received serious quantitative attention. This line of research includes Pijoan-Mas (2006), Marcet, Obiols Homs, andWeill (2007), Flodén (2006), Flodén and Lindé (2001), Li and Sarte (2006), and Chang and Kim (2005, 2006). Taken as a whole, the preceding body of work suggests that variable labor supply may be an important mechanism by which households maintain smooth paths of consumption. …

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