I was at a function yesterday with a bunch of economists – amongst some other people – and was annoyed to note that there wasn’t much push-back against the casual assumption that the cash handouts had not worked – that people had just saved the money they were given. It all seems so logical, what with people’s confidence being down and all, and indeed what with household savings rates having shot up. At one point one of the participants in the discussion said that many people would use it to pay off their credit card debt.
Now if they use it to pay off their homeloan, I would agree that the money is likely to be saved quite possibly for a considerable time. But the claim was made that ‘they only used to pay off their credit card. The thing about using money to pay off outstanding credit card debt is that there are two classes of credit card debt. The first is the very temporary rolling one month debt of those people who pay off their balance in full every month. If they used the money to pay off that debt – then the money will shortly turn up in their bank accounts – because they’ll have less money taken out of their account the next month – having paid $950 of it off already. The next question is what happens to the money when it’s in the bank account. My guess is that most of it would be saved – because these are fairly (financially) rational people. But of course even in this cohort, the owner of the regularly paid off credit card (or their spouse) might still have a relationship with their outstanding bank balance a bit like Oscar Wilde who said that he could resist anything . . . except temptation.
But what of the others, who don’t pay off their credit card each month? Pardon me for being so blunt, but they’re the mugs that the banks are counting on to make credit cards so lucrative for them. Here they are, often paying off their home loans, often with substantial equity in them which would enable them to reborrow. And they choose instead to pay 13 odd percent interest on their credit balances under their cards. Even if they don’t have equity, it’s habits like this that have led them to not having it. A tight month or two could enable them to join the club paying no interest on their credit cards. But they’ve not done this.
Do these people (they may include you), sound rational to you? Would you want to apply the ‘permanent income hypothesis‘ to predict their expenditure, or would you think that their expenditure smacks of adaptive expectations – that (within or without various longer run savings routines like paying off their homeloan and perhaps salary sacrificing some portion of salary) if there’s a bit more money around, it gets spent? If that’s not the case how (the hell) did they get to be paying 13% interest. If you were sympathetic to my reasoning, you wouldn’t expect to see all the monty spent the month it turns up in the account, but over a series of months as the credit card seems so much shier of maxing itself out.
So I think an important metric is what proportion of people pay off their credit card in full. They may not be incredible calculating machines, calculating their permanent income requirements every hour of the day, but they do at least pass a basic standard of rationality – they’ve noticed that paying 13% interest is something to avoid if possible and convenient.
I asked someone in one of the major banks what the figure was. What do you reckon it is?