Rational exuberance at the mall: addiction to carrying a credit card balance

Abstract

The Becker-Murphy model of rational addiction is tested with New Zealand credit card debt data. The results clearly favour the rational addiction model over the myopic, backward-looking model. The estimated short-run and long-run price elasticities are −0.58 and −2.32 respectively, and the estimated rate of time-preference is 6.7% per quarter.

Acknowledgements

We are grateful to Elisabeth Gugl and Carl Mosk for their helpful comments, and to Weshah Razzak for his assistance with data acquisition.

Notes

¹ The data are collected and calculated from the Reserve Bank of New Zealand's Money, Credit and Financial Statistics, and from Statistics New Zealand.

² None of the series exhibit structural breaks, and this simplifies the unit root and cointegration testing.

³ If the lag length in the VAR models is shortened to four, the Johansen tests suggest there are two cointegrating relationships. Some experimentation with error-correction specifications yielded implausible results with regard to the signs of the estimated coefficients and the implied rate of time preference.

⁴ This test was based using p_{t− 1} and p_{t+ 1} as instruments for c_{t− 1} and c_{t+ 1}, it allowed for the MA error process, and the Newey-West covariance matrix estimator was used. The test statistic is asymptotically chi-square with two degrees of freedom.