Liquidity Constraint Threat and Household Indebtedness

Abstract

Using individual-level credit card data, this study examines the efficacy of a consumer financial regulation designed to curtail the accumulation of unsecured debt among households. The implementation of a non-binding penalty, entailing the suspension of all existing unsecured credit for heavily indebted individuals, leads to a 9.9% greater reduction in monthly credit card debt among credit card revolvers compared to non-revolvers following the policy announcement. We also document significant reductions in other outcome variables, including credit card spending, balance, and delinquency. Significant debt reductions are observed even among revolvers who are distant from the penalty threshold. Consistent with a decision weight mechanism whereby individuals tend to assign heightened importance to extreme negative events, the credit card debt response is more pronounced among revolvers whose existing unsecured credit is more important.

Keywords: Liquidity Constraints, Household Indebtedness, Financial Regulations, Unsecured Debt, Credit Suspension, Credit Cards, Household Finance

JEL Classification: D12, D14, D91, E51, E62, G21, G28, G51, J22, J31