Unexpected Expenditure and High-cost Credit


A large number of households in the US hold little or even negative liquid wealth for prolonged periods of time, and face a high marginal cost of borrowing. I find that the use of high-cost credit such as payday loans is associated with (a series of) unexpected expenditures in families with low permanent income. Using PSID and the Consumer Expenditure Survey, I document that unexpected expenditures such as hospital visits and repairs tend to be more pervasive among low-wealth households. I construct a model where households face a trade-off between saving and life quality investment. A lack of investment in life quality leads to a deficit which increases the propensity of expenditure shocks. I study the effect of redistribution policies on reducing the occurrence of expenditure shocks and consequently the use of high-cost credit, as well as the welfare implications.