Credit Cards by Nick Youngson is licensed under CC BY-SA 3.0
Caps on interest rates are not a new idea in Washington. Senators Bernie Sanders (I-Vt.) and Josh Hawley (R-Mo.) have previously cosponsored legislation to cap credit card interest rates at 10 percent in the name of consumer protection. In reality, such a policy is shortsighted and would inflict harm onto middle-class and low-income individuals.
Interest rate caps are a form of price controls at their core. The consensus is clear among all types of economists that price controls lower supply, increase scarcity, and create more problems than they solve.
In the 1970s, President Nixon famously froze prices and wages for 90 days to try and alleviate persistent inflation. The inflation was never solved but only suppressed temporarily. It took the Fed tightening the money supply in the 1980s to fix inflation for the next 40 years until the next inflationary episode was ignited by the Biden administration’s disastrous and profligate spending projects.
Interest is the cost of borrowing today priced in future cash flows. Interest reflects risk, which is why large corporations and sovereign governments can often borrow at single digit rates, while ordinary consumers, who are riskier to lend to face higher interest rates to offset the probability of default and missed payments.
The data on the potential impact of a 10 percent interest rate cap is clear. Most Americans would likely lose access to their credit cards. A study conducted by the Electronic Payments Coalition finds that 82-88% of Americans could potentially be cut off from consumer credit. A 10 percent rate cap would mean only borrowers with pristine histories and high incomes would qualify for credit cards.
This would be a major step in the wrong direction. It is estimated 80% of Americans have access to credit cards. Consumer credit is a crucial financial tool that helps people pay for unexpected emergencies such as repairs, healthcare expenses, and other unforseen costs. The Federal Reserve found that 37% of Americans would be unable to pay for a $400 emergency expense using cash or an equivalent form of money, meaning they would likely resort to using credit cards to cover such expenses.
Consumer spending drives roughly 70% of US GDP. This means that rate caps and policies limiting consumer spending power will invariably harm GDP growth. Credit card spending volume represents over 20% of US GDP. Removing credit access for hundreds of millions of Americans through a rate cap would certainly harm the economy. Its effects would be felt by all businesses, small and large, and hamper payroll growth as well as wage growth.
Attempts by the government to intervene in markets are not immune to circumvention. When supply is artificially restricted, demand does not simply disappear. It migrates to other venues such as black markets. Borrowers could wind up resorting to payday lenders to access needed credit, often at rates much higher than ones offered by financial institutions.
During a recent press briefing, Speaker Johnson expressed skepticism regarding a rate cap on credit cards, saying “That would have a negative effect on a lot of people who work on revolving credit. So it’s something that we got to be very deliberate about”.
While such policies are framed as a fix to the problem affordability, they are likely to exacerbate affordability concerns by removing a key source of purchasing power without addressing the root cause of high prices. Congress should instead address hidden costs that drive up interest rates, such as the high cost of compliance burdens, stress testing, bank exams, and regulations that are passed on to consumers in the form of higher borrowing costs.
