Abstract
This paper discusses whether the use of credit cards reduces aggregate money holdings in an economy. Applying and modifying the Baumol-Tobin model (Baumol Quarterly Journal of Economics 66:545–556, 1952 and Tobin Review of Economics and Statistics 38(3):241–247, 1956), it studies how much money a credit card bank would normally maintain to support retail trade, and shows that whether or not the use of credit cards actually reduces the aggregate demand for money depends on how often consumers visit the bank and how long it takes to clear a check. With innovations in the banking industry such as ATMs, online banking, and other electric funds transfer services, the cost of visiting banks (i.e., switching funds between a checkable account and an interest-earning account) is now very low. For the whole economy, as a result, the use of credit cards may not necessarily reduce aggregate money holdings.
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Notes
Credit card billing cycles are generally about one month with a due date approximately 15 days after the end of the cycle.
In reality there is a great deal of variability in the number of days it takes for a merchant to receive payment from the credit card bank but between 1 and 7 days would not be unreasonable.
Special thanks to Joe Evans, President and CEO, United Bankers, LLC for insight into this process.
The homogeneity in consumers’ spending is not essential in the analysis, and it can be readily shown that heterogeneity in consumers’ spending does not change the outcome.
In the real world, most employers pay their employees monthly or biweekly at the end of the period which can also be interpreted as the beginning of the next period.
Akhand and Milbourne (1986) studied the determination of the optimal N, taking the interest rate of bonds and switching cost as the parameters. We treat N as an exogenous variable here, since our focus is on aggregate money holdings, including those held by credit card banks. Nonetheless, the current innovation in banking service makes the switching cost almost negligible.
For an example of credit card securitization, see the Credit Card Securitization Manual published by the FDIC and available online at http://www.fdic.gov/regulations/examinations/credit_card_securitization/ch3.html.
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Bill Z. Yang Thank Mr. Joe Evans, the President and CEO of United Bankers, LLC for his first-hand information about the practice in credit card business as well as Richard Cebula, George Carter and the participants of the IEAS Annual Conference at Charleston, SC for their comments on an earlier version. The standard disclaimer applies as usual.
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Yang, B.Z., King, A.S. Do Credit Cards Really Reduce Aggregate Money Holdings?. Atl Econ J 39, 85–95 (2011). https://doi.org/10.1007/s11293-010-9254-y
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DOI: https://doi.org/10.1007/s11293-010-9254-y