The real effects of liquidity on behavior: evidence from regulation and deregulation of credit markets

Abstract

Economies around the world are marked by major interventions in credit markets. Institutions ranging from central banks to the Grameen Bank operate under the assumptions that credit markets are imperfect, that these imperfections can be ameliorated, and that doing so increases output. There is surprisingly little empirical support for these propositions. Chapters 1 and 2 develop evidence on related questions by exploiting changes to a major intervention in U.S. credit markets, the Community Reinvestment Act (CRA). Using data on both banks and potential commercial borrowers, Chapter 1 develops evidence that CRA does increase credit to small businesses as intended. Chapter 2 then exploits these CRA-induced supply shocks to identify the impact of credit increases on county-level payroll and bankruptcies. There is some evidence of real benefits at plausible implied rates of return on CRA borrowing, and little suggestion of crowd-out or adverse effects on bank performance. The findings therefore appear consistent with a model where targeted credit market interventions can improve efficiency, although important questions remain. Despite a growing number of studies concluding that a substantial proportion of US households are liquidity constrained, there remains little consensus as to the quantitative importance or nature of these constraints. This paper develops a new type of evidence on the impacts of consumer credit markets on behavior by examining household-level responses to an exogenous liquidity shock.

(cont.) A United States Supreme Court decision effectively deregulated bank credit card interest rates in December 1978, and I develop evidence that consumers from states with binding usury ceilings before the decision became more likely to hold bank cards after the decision, relative to their counterparts in unaffected states. The marginal cardholders appear to have characteristics widely associated with credit constraints, and to borrow frequently on their new cards. Yet there is little evidence that these cardholders exploit their newfound liquidity by shifting into higher-yielding, less liquid, or riskier assets. This finding is at odds with most models of liquidity constraints, and motivates consideration of alternative explanations for the widely observed sensitivity of consumers to liquidity.