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

See all articles by David S. Evans

David S. Evans

Global Economics Group; University College London

Robert E. Litan

Council on Foreign Relations (CFR) - Council on Foreign Relations- Washington D.C.

Richard Schmalensee

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: February 22, 2011

Abstract

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

Evans, David S. and Litan, Robert E. and Schmalensee, Richard, The Economic Principles for Establishing Reasonable Regulation of Debit-Card Interchange Fees that Could Improve Consumer Welfare (February 22, 2011). Available at SSRN: https://ssrn.com/abstract=1769890 or http://dx.doi.org/10.2139/ssrn.1769890

David S. Evans (Contact Author)

Global Economics Group ( email )

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University College London ( email )

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Robert E. Litan

Council on Foreign Relations (CFR) - Council on Foreign Relations- Washington D.C. ( email )

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Washington, DC 20006
United States

Richard Schmalensee

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

Room E62-525
Cambridge, MA 02142
United States
617-253-2957 (Phone)
617-258-6617 (Fax)

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