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When interest rates go up one percent (not one percentage point), what happens to demand for credit? I've only been able to find two papers in this area:

  1. Gross and Souleles (2001) study credit cards and find -1.3%
  2. Follain and Dunsky (1997) study mortgages and find as -1.5 to -3.5

There are two margins here of potential interest. First, shocks to one borrowing rate can shift borrowing into other sources, leading to overestimation of total debt elasticities. Second, shocks to borrowing rates can lead to a mixture of lower spending overall and more cash spending. Overall wealth is an interesting example of the other the latter, because wealthy households can choose to spend less or borrow less in response to higher rates while poor households can only spend less.

Are there papers I've missed that study this effect? Of particular interest are studies that additionally explore these effects on different sub-populations.

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Are you referring to theoretical models more sophisticated than the simple static model of demand for a good and its price, or to empirical studies which attempt to measure the relation? –  Alecos Papadopoulos Nov 21 at 17:48
    
I am primarily interested in empirical estimates. –  BKay Nov 21 at 18:35

1 Answer 1

These papers look relevant, to one degree or the other:

Karlan, D., & Zinman, J. (2009). Observing unobservables: Identifying information asymmetries with a consumer credit field experiment. Econometrica, 77(6), 1993-2008. The authors write:"We estimate the presence and importance of hidden information and hidden action problems in a consumer credit market using a new field experiment methodology. We randomized 58,000 direct mail offers to former clients of a major South African lender along three dimensions (...) These three randomizations, combined with complete knowledge of the lender's information set, permit identification of specific types of private information problems. (...) We find strong evidence of moral hazard and weaker evidence of hidden information problems."

Mandell, L. (1971). Consumer Perception of Incurred Interest Rates: An Empirical test of the efficacy of the Truth-In-Lending Law. The Journal of Finance, 26(5), 1143-1153. "The purpose of this article is to use national sample survey data to measure the effect of the Truth-in-Lending Law (enacted in 1969) on the consumer’s knowledge of interest rates that he is actually paying on an installment loan.(...) Aside from measuring the overall effect of the law on all persons, analysis of various population subgroups will be made to see whether the law has had differential effects upon the interest rate perception of persons based upon personal characteristics such as age, income, amount borrowed, total debt and education."

Calem, P. S., & Mester, L. J. (1995). Consumer behavior and the stickiness of credit-card interest rates. The American Economic Review, 1327-1336. The authors present empirical evidence (from a 1989 Survey) that supports the "stickiness" of credit card interest rates, attributing it, as they write, to "(i) consumers facing search costs; (ii) consumers facing switch costs; and (iii) firms facing an adverse-selection problem if they were to unilaterally reduce their interest rates."

Ausubel, L. M. (1991). The failure of competition in the credit card market. The American Economic Review, 50-81. The original paper to which the previous one provided additional support. It contains both theoretical discussion and empirical evidence, as well as counterfactual calculation (what "would" the interest rates be if perfect competition held in this market).

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Hi there, thanks for these. As we're trying to build a body of awesome content here, we love answers that contain the substance of the answer to the question. Could you perhaps add a sentence or two to each reference, to describe how it addresses the question: I know the paper titles do that to some extent, but a bit more about how each directly relates to the question as asked would be great –  EnergyNumbers Nov 21 at 21:00
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@EnergyNumbers Personnaly, I am not against answers that are pure lists of references. They may be uninteresting for the casual internet surfer, but they're worth their length in gold for the researcher and for the graduate student. But, since you asked, I will add some commentary. –  Alecos Papadopoulos Nov 21 at 21:49
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@EnergyNumbers Commentary included, as I have committed. –  Alecos Papadopoulos Nov 22 at 21:33
    
Nice one, thanks –  EnergyNumbers Nov 22 at 21:57

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