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Policy Brief, December 2022
The Middle Class Is Saving Less, and High-Cost Credit Card Debt May Play a Major Role

Recognizing an onslaught of economic challenges since the Great Recession, many economists and policymakers have expressed concerns that the middle class—long considered a cornerstone of the American economy—has been shrinking or becoming unattainable. Understanding the so-called phenomenon of the “squeezing” of the middle class has been an active area of scholarship and active public policy deliberations.

I had the opportunity to edit a volume of research papers on the middle-class economic crisis, presented at a community development research conference organized by the Federal Reserve System. Each paper offers new evidence on the changing conditions of the middle class.

In my own contribution to the series, I shed light on a significant barrier to economic resilience and mobility for middle-class households: liquidity constraints associated with the rising cost of credit card debt. Households are “liquidity constrained” when they lack liquid wealth—for example, easily accessible cash—that allows them to pay for expenses and still save for essential investments like education and homeownership. I also find that the inability to borrow at low interest rates, specifically, is a large driver of household liquidity constraints and may thus limit future opportunities to save. For policymakers, understanding the challenges confronting middle-class households in their borrowing and savings decisions offers important context for the design of a range of policies, from tax policy to consumer financial protection to education and much more.

A shrinking and liquidity-constrained middle class

Using Survey of Consumer Finances Data (SCF), from 1998 to 2016, I study U.S. households that are members of the middle class. Because there is no single definition of what it means to be “middle class,” I consider several different definitions to identify which households belong in the middle class. For example, under one definition a household is middle class if they are below the top five percentiles of the wealth distribution, they have financial assets, they have after-tax disposable income that is above the poverty line, and they did not receive Supplemental Nutrition Assistance Program (SNAP) in the previous year. Under this definition, I calculated that the average sum of financial assets and disposable income of a middle-class family was just above $110,000 in 2016. (Prior to the Great Recession in 2007, it was just above $145,000). In this example, low-wealth households that do not meet these criteria are defined to be poor and high-wealth households are defined to be rich.

Consistent with other research, my results show that, even under different definitions of middle class, both the number and percentage of middle-class households have been declining, on net, over time while the number of poor households has been increasing. These declines help explain why the share of total population-wide financial assets plus disposable income held by the middle class went from 20% in 2001 to 12% in 2013.

Next, I show that approximately 80% of households in the middle class are liquidity constrained. A household is liquidity constrained when its liquid wealth is low relative to its disposable income or when the household reports they were turned down by a lender or did not apply for credit because they feared not being approved.

The connection between debt, high interest rates, and liquidity constraints

I then account for the rising share of middle-class households who are liquidity constrained. I show that following the Great Recession, liquidity-constrained households have become more indebted, as evidenced by rising debt-to-disposable income ratios. I also find that as the average interest rates on credit card debt held by households increase, so does the likelihood that middle-class households are liquidity constrained, suggesting that higher debt-service burdens may be a factor in explaining low levels of liquid wealth or denial experiences in the credit market. Importantly, a growing number of middle class and poor families paying average interest rates on credit cards of more than 15% are also facing monthly debt payments of more than 30% of their monthly disposable income. High debt payments relative to income and high-interest-rate credit cards may reinforce constraints, and in turn, may challenge the ability to save for needed future expenditures that are typical for middle-class families.

The connection between liquidity constraints and savings

While it might not be surprising that poor households are more likely to be both liquidity and credit constrained, it is less obvious that such conditions should be pervasive among middle-class households who tend to have access to credit and have seen their wealth grow over the years due to various financial innovations and increases in asset prices. Liquidity constraints are relevant for middle-class households because they may be a sign a family will face financial difficulties if confronted with a large, unexpected expense. As my research suggests, they may also foreshadow the challenges that middle-class households may face when paying for a large purchase down the line, such as a car, children’s college education, or a first-time home purchase.

In the last part of my analysis, I examine whether liquidity constraints appear to influence households’ decisions to save for expenses related to their children’s college education, a first-time home purchase, or for later-in-life medical needs. My analysis of SCF data shows that both poor and middle-class households are significantly less likely to save for children's education, later-in-life medical needs, and a first-time home purchase than wealthy households. My research also finds significant ethnic/racial gaps in savings, income, and wealth between White households and Hispanic and Black households.

Finally, I find that higher monthly debt-payments-to-income ratios and higher average interest rates on credit cards debt are associated with a 15% decrease in the likelihood of saving for these expenses among middle class households. This research contributes to our understanding of how liquidity constraints and the so-called “soft constraints” of high monthly debt payments may create challenges for middle-class households saving and paying for these large purchases.

My paper contributes to a sizeable evidence base for how and why households save by helping focus policymakers’ attention on the middle class and offering empirical estimates that point to a connection between liquidity constraints and savings by middle class households.

Opinions expressed in this article are those of the author(s) and do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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