Layton's First Promise

My first blog post in a while is focused on Jack Layton and his first campaign promise of the year: cap the interest rate that can be charged by credit card companies.

The premise of Mr. Layton's promise: household debt is one of the most serious problems facing Canadians.

While I don't necessarily disagree with his premise, especially as one who is both trying to pay off my debt and who grew up in a fiscally conservative culture (i.e. southern Alberta), I do think that this policy is missing (or simply ignoring) some very important economic principles.

Economists consider the interest rate to be the "cost" of borrowing money. Interest is essentially a fee charged to a borrower that makes lending profitable. If you lower the cost of borrowing, people borrow more. That means an increase in the amount of debt people will have, not a decrease. High interest rates are a large deterent to taking on excessive debt. If you decrease this deterent, people think "hey my minimum payments will be lower, so I can afford to borrow more." In addition, card companies are likely to increase maximum limits so as to maintain profitability.

This actually implies that, in the long run, the average Canadian debt load is likely to increase.

Where reform is needed is in people's understanding of how credit card companies work and transparency within the industry. Hidden fees, rates changes, and the like need to be made more explicit so that individuals and families can make smarter decisions regarding their debt load and internalize the true costs of credit card debt. Layton calls for voluntary practices recently established to become mandatory. This policy would be much more beneficial.