Ocasio-Cortez’s Plan to Cap Interest Rates is a Horrible Idea – Eccentric Economics

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While going through my daily news feed, I stumbled upon another headache-inducing headline about Alexandria Ocasio-Cortez’s and Bernie Sanders’ proposal to mandate a federal cap on credit card interest rates. Those who are unfamiliar with the importance of interest rates as well as some religious sects may agree. Centuries ago, the practice of usury was looked down upon, with reformers seeing it as a means for those who hold wealth to take advantage of the less fortunate. In due time the field of economics grew with intellectuals, and the debate settled on the notion that interest rates are greatly beneficial to society.

Contrary to the commonly-accepted belief that interest rates are an arbitrary number set by greedy capitalists who seek profits without engaging in labor, interest rates in fact have a deeply-rooted meaning. To put it briefly, the market interest rate is a reflection of both the genuine supply of available savings and the market demand for those savings, both of which are guided by an economic actor’s time preference. The suppliers of interest lending withhold consumption of goods and services and their reward for doing so is additional money being contributed to their savings. They then supply this savings to consumers who seek to utilize those savings for whatever economic purpose they see fit.

When an economic actor has a low time preference, he may choose to invest his savings in a particular venture that will grant him a profit in the future which reflects the supply side of savings. On the other hand, when an economic actor wants something now instead of in the future, this reflects a high time preference and they pay a premium (interest) which represents the demand for genuine savings.

Like other resources, time is scarce and is subject to economizing. This concept is not exclusive to lending, but is also applied to labor wages, the production structure, and so forth. For example, a laborer receives wages well before the product is completed, reflecting a high time preference and the profit the entrepreneur may receive in the future is not yet granted. Because the entrepreneur may suffer losses instead of profits, he inserts interest into the wages to offset the risk. This is otherwise known as the discounted marginal value product. Contrary to other progressive populist terms such as a living wage, this principle is what reflects actual market wages.

Now that we grasp that there is a fundamental significance behind interest rates, what happens when an artificial ceiling caps their amount? The determination of the interest rate also maintains a very important factor that is part of the equation: risk. Those with high credit scores receive lower interest rates, while those with lower credit scores maintain higher interest rates. The higher interest rates are simply premiums that consumers, who have an unattractive history of paying back their debts, pay.

Lending is a valuable tool for market activity, and it allows those with low savings to engage in economic actions they otherwise could not. It provides producers funds to grow their businesses and entrepreneurial ventures, and also helps consumers purchase necessities they otherwise could not afford in the present, hence their high time preference.

Like any other economic good or service, interest rates are subject to the laws of supply and demand. The supply of genuine savings and the demand for those savings embody the interest rate, and this is reflected by its price. When the price of a good or service is capped, this produces a disincentive for entrepreneurs and suppliers to engage in economic activity in the affected industry. This is simultaneously coupled with an artificially low price, which in turn increases demand. The result of a decreased supply and an increased demand is a shortage.

Not only will there be fewer lenders, but this will discriminate against high risk consumers who are seeking a loan. If the lender assumes the risk is not worth the reward, they simply will not grant the loan. Like nearly every other progressive economic policy, Ocasio-Cortez’s proposal to help the unfortunate will be met with negative repercussions that will in fact hinder their ability to engage in this valuable market activity.

Frankly, creditors would simply stop granting credit cards to those with lower credit scores, because the risk of the consumer defaulting is not worth the now limited profit. The poor who rely on credit to pay for expenses would have no choice but to starve until they receive their next paycheck. If this proposal were enacted, there would be a decrease in auto loans for the poor who need transportation, personal loans for various unintended expenses, mortgage loans for housing, and so forth.

The government has an extensive track record of combating this response from the market, which played a hefty role in delivering us many economic woes such as the mortgage crisis that led to the recession of 2008. Congressional decrees such as the Community Reinvestment Act forced institutions to grant loans to consumers with low to moderate income, representing a great deal of risk. Additionally, the Zero Down Payment Act of 2004 enticed those with low genuine savings to purchase homes through the government FHA program that they could not afford. The result was not only defaults, but it encouraged investors to enter the market and misallocate their scarce resources into an industry that did not reflect genuine demand and supply.

There are consequences for artificially altering the market’s tendency towards equilibrium. Interest rates play a very important role in the modern economy, and in their absence we would have no choice but to make do with what is in our possession in the present. Like many other well-intended policy proposals, any attempt to alter the price of interest rates bears negative repercussions that will harm the same people they intend to help.

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Logan Davies

Logan Davies is a Regional Manager in the Banking Services industry, and the director of the non-profit organization, Voluntaryism in Action. He graduated from Middle Georgia State University with a degree in Business Administration. He is the father of a loving son, an avid outdoorsman, firearm enthusiast, and unwavering supporter of liberty.

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