April 17, 2015

Credit Is a Powerful Tool for American Families

Todd Zywicki

George Mason University Foundation Professor of Law, Antonin Scalia Law School, George Mason University

Thomas A. Durkin

Summary

Consumer credit is often thought to be just a way to live beyond one’s means and to shift consumption – to spend today instead of saving for tomorrow. But the assumption that families use credit profligately is misleading. To understand how consumers use credit – and why it is a boon to American families and the economy – it is useful to understand how businesses use credit.

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Americans have an ambivalent relationship with non-mortgage consumer credit: We all use it, yet we feel as if there is something slightly wrong about it. Should we?

Consumer credit is often thought to be just a way to live beyond one’s means and to shift consumption – to spend today instead of saving for tomorrow. But the assumption that families use credit profligately is misleading. To understand how consumers use credit – and why it is a boon to American families and the economy – it is useful to understand how businesses use credit.

Businesses use it for two basic reasons: to invest in capital goods and to smooth income and expenses. Capital goods generate a stream of benefits over time – for example, a construction company could employ workers with shovels to dig foundations for buildings or buy a backhoe to do the same work and finance it out of the crew’s increased productivity.

Similarly, businesses can use credit to deal with short-term fluctuations in revenue and expenses – a retailer might finance its operations on credit during lean times and then pay it back when profits return and more inventory is needed.

But what is often not appreciated is that households overwhelmingly use credit for the same purposes. Much of our use of consumer credit is for investment purposes, such as to buy a home or to use student loans to increase our human capital and earn a higher-paying job.

But most of our big-ticket expenditures have this same characteristic: cars, refrigerators, televisions and other household durables. Consider, for example, the humble washing machine. Its value is the time and money it saves from not having to schlep to the laundromat every weekend with a pocket full of quarters. Refrigerators save us time-consuming trips to the grocery store or eating out; cars expand our job options. In short, the bulk of non-mortgage consumer credit is used to buy consumer durables that generate a stream of benefits over time.

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