Why the Federal Reserve’s Plan to Improve the Digital Payment System Is Likely to Backfire

Among other things, the Fed argues that it will need more than ten years just to recover its operating costs.

In its latest effort to expand its role, the Federal Reserve has been working on a billion dollar, 5-year plan to launch a new operation entitled FedNow. The Fed hopes this will allow Americans to send and receive payments within seconds, bringing America’s payments system up to speed with much of the rest of the world.

While I can’t deny that such intentions deserve praise, peering below the surface shows a vastly different picture.

What’s Wrong with Payments Now?

Don’t worry if you are not familiar with this. It’s one of those issues in economics that is rather niche yet holds important consequences. However, it’s not difficult to get up to speed. Just consider the following question: Which is the fastest way to send $42 from your home in D.C. to someone in London: transfer it digitally or buy a plane ticket to hand deliver it?

Believe it or not, it is actually faster to fly to London to deliver a payment than to wait for a digital transfer to process, clear, and be available to be withdrawn. This probably sounds more than a little strange, but I can all but guarantee you have encountered these delays before. Think about the notification that PayPal sends when you transfer your account balance to your bank. Or, check your credit card statements for pending charges.

These delays stem from the very foundation of America’s payments system.

And for the majority of Americans, this is mostly only an inconvenience. It’s inefficient, but it’s a cost that goes unseen. It’s when you stop to consider those living paycheck to paycheck or businesses pinching every penny to get by that a 3-5 day delay can have serious, extended consequences.

The Folly of Government Intervention

A solution is needed, but it’s not immediately clear that the answer is government intervention. When discussing a different government project, Lawrence White correctly states, “An economist’s first question of any proposal for a government-sponsored enterprise is naturally: What’s the evidence that the existing market is inefficient?” And this is precisely where the folly of FedNow is revealed.

FedNow is five years away, but that’s not to say there are no options today. There is actually a private sector alternative offered by the Clearing House and it has been growing since 2017. Further, this private alternative was spawned from the Fed’s own call for help! It was only after a billion dollars of private sector investment and a list of banks had signed up that the Fed announced it, too, would enter the ring.

At this point, it is actually the Fed that has positioned itself to introduce inefficiencies to the existing market. This becomes abundantly clear when we look at the proposal for the program. Among other things, the Fed argues that it will need more than ten years just to recover its operating costs.

What private business is given this much time to pay off its operating costs?

Not only is this unlikely in the private sector, it is also a clear price signal that this is an inefficient allocation of resources. In arguing for this extended period, the board even admits that a traditional 10-year cost recovery period could result in “volatile prices or prohibitively high service fees” that would “negatively affect service usage.” In other words, they expect the costs to be so high that no one would use it. Imagine using that argument with your local bank. I dare say you’d be leaving without a loan.

Unfortunately, as readers of FEE no doubt recognize, governments do not always abide by the lessons of economics. And it’s not just immediate players who will suffer for this. Yes, the private sector largely froze when the initiative was first announced, and it will have an uphill battle competing when the Fed’s program is launched. But these are not the only consequences to consider.

What’s going to happen when the government calls again for the private sector to solve an issue? Those that know of FedNow’s rise to power will be unlikely to invest in a solution knowing that it’s possible for the federal government to suddenly announce itself as a chief competitor. Further, this undermines the legislation that is supposed to restrict the powers of the Fed. What good is a spending restriction if one can arbitrarily change the guidelines?

A Simpler Solution

As if this were not enough, it’s not like the Fed is being forced to choose only between sitting idly by or proceeding with FedNow. George Selgin has regularly argued that there is a simpler solution. Instead of operating with traditional banker’s hours (i.e. 9-5 Monday through Friday, and off most holidays), the Fed could dramatically change the situation by simply expanding to a truly full-time operation: 24 hours a day, 365 days a year.

This seems like a win to me. Americans get faster payments today and there is no disruption of the market.

However, I’m not sure the Fed would consider this a win, and it seems that they recognize this. For while they could help countless Americans today with an expanded operating system, I fear the allure of mission creep is too great. It is the measure of success in most political circles and an unfortunate reality to contend with. However, that should not stop us from criticizing government disruptions of the market or calling attention to misallocations of resources––especially those disguised as otherwise well intentioned.