Why Do Financially Unconstrained Individuals Respond to Higher Credit Limits? *

Abstract

This paper uses unique bank-account-level panel data from a leading Indian bank to explain why credit access boosts consumption and reports several novel findings. Consumers spend 7.8 cents on average for every \$1 increase in credit limit in 12 months after the limit increases despite low \textit{ex-ante} credit utilization and high liquid savings. Importantly, consumption growth is not financed by borrowing. Rather, the consumption response is increasing in income and liquidity and is higher for individuals with lower labor income uncertainty and consumption uncertainty. Our findings are inconsistent with either currently binding liquidity constraints or precautionary savings motives. Instead, we present a theoretical framework that illustrate how cues may stimulate consumption, and then test the cue theory using a few proxies. The results support the idea that credit limit hikes serve as cues that trigger consumption.

Keywords: consumption, credit card, cue theory, financial decision-making, household behavior, liquid buffers, precautionary savings, liquidity constraints, mpc, credit

JEL Classification: D14, E21, E51, H31