Question

the imploications of payday loans on theories for policy design

Answer 1

There are always a large section of society that is unable to save anything out of their income. For these groups there are payday loans which provide instant cash to be used in emergency and is paid in advance against the next paycheck. Because they fulfill the short term need they charge an exorbitant interest. They are able to raise welfare but can also lead the groups of consumers to be indebted for years. The problem of adverse selection makes the policy design difficult because the most vulnerable groups self select themselves and expose themselves towards interest rate risk and default risk.

Interest rates are as high as 390%. The policy design has achieved a quite limited sucecss especially when it has restricted the ability of lenders to advance further loans to people with poor credit histrory. Because borrowers borrow more money to pay off the previous loan, this leads to a vicious circle of debt, making policy design more complex.