The effect of pricing on demand and revenue in federal reserve ACH paymentprocessing

Because the automated clearinghouse (ACH) has been found to have lower soci al costs than paper checks, the Federal Reserve has been promoting more wid espread use of ACH by lowering ACH processing fees. In this paper, we have obtained the first numerical estimates of ACH demand elasticities, a measur e of the responsiveness of ACH demand to price changes. Various methods are employed to estimate the demand elasticities to determine how robust the e stimates are. During the period 1985-1996, the Federal Reserve lowered the per-item price of interregional ACH, while the per-item price of intraregio nal ACH stayed constant. We take advantage of this unique pattern of histor ical price changes implemented by the Federal Reserve to estimate the effec t of price changes on demand for ACH. We find that the volume of ACH processed by the Federal Reserve responds to changes in per-item fees, but the increase in volume that results from a p rice decline is very small and not statistically significantly different fr om 0, except in the case of debit origination. The results suggest that the Federal Reserve cannot expect to generate substantial additional volume by lowering its prices further. However, commercial banks may be able to incr ease the volume demanded by lowering their own ACH fees. We also examine ho w volume growth initiated by a price cut affects unit costs. Given the rela tively large-scale economies found for ACH, volume growth leads to lower un it costs. However, to outweigh the revenues lost as a result of a price dec line, ACH volume would have to increase by an amount much greater than our estimates indicate is likely. Consequently, a decline in per-item ACH fees likely would lead to lower net revenues.