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Why are credit card rates sticky?

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Summary

This paper investigates credit card rate stickiness using a screening model of consumer credit markets. In recent years, while the cost of funds has fallen, credit card rates have remained stubbornly high, spurring legislators to consider imposing interest rate ceilings on credit card rates. The model incorporates asymmetric information between consumers and banks, regarding consumers' future incomes. The unique equilibrium is one of two types: separating (in which low-risk consumers select a collateralized loan and high-risk consumers select a credit card loan), or pooling (in which both types of consumers choose credit card loans). I show that a change in the banks' cost of funds can have an ambiguous effect on the credit card rate, so that the credit card rate need not fall when the cost of funds does. Usury ceilings on credit card rates are detrimental to consumer welfare, so would be counter to their legislative intent.

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Authors and Affiliations

  1. Research Department, Federal Reserve Bank of Philadelphia, Ten Independence Mall, 19106-1574, Philadelphia, PA, USA

    Loretta J. Mester

  2. The Wharton School, University of Pennsylvania, 19104, Philadelphia, PA, USA

    Loretta J. Mester

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  1. Loretta J. Mester
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Additional information

I thank George Mailath, Paul Calem, Gerhard Clemenz, Sally Davies, George Kanatas, Leonard Nakamura, Tony Santomero, Tony Saunders, participants in the 1990 Financial Management Association Meetings, and co-editor Michael Woodford for helpful comments.

The views expressed here are those of the author and do not necessarily represent the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System.

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Mester, L.J. Why are credit card rates sticky?. Econ Theory 4, 505–530 (1994). https://doi.org/10.1007/BF01213621

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  • DOI: https://doi.org/10.1007/BF01213621

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