The Economic Principles for Establishing Reasonable Regulation of Debit-Card Interchange Fees that Could Improve Consumer Welfare
28 Pages Posted: 26 Feb 2011 Last revised: 1 Mar 2011
Date Written: February 22, 2011
This paper uses the standard economic framework for designing government regulations to evaluate the Federal Reserve Board’s proposed cost-based price caps for debit card interchange fees. We argue that the Board has not prepared an economically sound diagnosis of the problem that it is trying to fix and therefore has no basis for knowing whether its proposals are reasonable or not as required by the Dodd-Frank Act. We summarize the economics literature, which finds that cost-based regulation is not appropriate for interchange fees or any other regulation of price structures in two-sided markets. With the wrong diagnosis and the wrong remedy, it is not surprising that the proposed regulations would impose significant harm consumers and have no countervailing benefits. We conclude that the Board should withdraw the proposed regulations and rely on the two-sided market framework, which would require estimation of merchant and consumer demand for debit cards, to determine the socially efficient interchange fee. We present preliminary results that suggest that the market-set interchange fee is likely to be close to the socially efficient interchange fee. In any event, the Board should propose regulations that at least do not harm consumers.
Keywords: Debit Cards, Interchange Fees, Financial Regulation
JEL Classification: G21, G18, L51, L52
Suggested Citation: Suggested Citation