Central Bank Monetary Policy in the Age of Cryptocurrencies
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Bibliographic details
- Authors: DONG HE
- Published: June 1, 2018
- Volume: 55
Overview
- Publication: F&D Magazine, "Monetary Policy in the Digital Age" by DONG HE.
- Date and issue: June 2018, Volume 55 | Number 2.
- Core question: How should governments and Central Banks regulate the use of cryptocurrencies and cryptoassets, and what role should central banks play in crafting monetary policy fit for the digital economy?
- Context: Crypto assets challenge the paradigm of state-supported currencies and central banks' dominant role in the financial system; they derive value from exchangeability, payment use, and store-of-value expectations rather than legal-tender backing.
Future of money — key findings and risks
- Crypto assets may reduce demand for central bank money if they become widely used as payment media or units of account.
- Current limitations of crypto assets:
- Too volatile and risky to pose a material threat to fiat currencies today.
- Do not enjoy the same degree of trust as fiat currencies due to fraud, security breaches, operational failures, and association with illicit activities.
- Deflation and policy-function risks:
- Some crypto assets (e.g., Bitcoin) have limited inflation risk because supply is limited.
- Crypto assets lack three critical functions of stable monetary regimes:
- Protection against the risk of structural deflation.
- Ability to respond flexibly to temporary shocks to money demand and smooth the business cycle.
- Capacity to function as a lender of last resort.
- Potential stabilizing developments:
- Longer track records could reduce volatility.
- "Smart" issuance rules (possibly based on artificial intelligence) could make valuation more stable.
- "Stable" coins already appear: some pegged to existing fiat currencies; others attempt issuance rules that mimic inflation- or price-targeting policies (“algorithmic central banking”).
Payment shift, technology, and economic implications
- Advantages of crypto assets as medium of exchange:
- Offer much of the anonymity of cash while enabling long-distance transactions.
- Greater divisibility, attractive for micro payments in sharing and service-based digital economies.
- Faster clearing and settlement without intermediaries; cross-border payments can be reduced from days to seconds by bypassing correspondent banking networks.
- Shift from account-based to value- or token-based payment systems:
- Account-based systems: transfer of claims recorded in an account with an intermediary (e.g., a bank).
- Value- or token-based systems: transfer of a payment object whose authenticity/value can be verified without trust in intermediaries.
- Monetary-creation implications:
- Crypto assets resemble commodity money rather than credit money; could lead to declining demand for central bank money if adoption rises.
- If central bank money ceases to define the unit of account for most activities, the effectiveness of central bank monetary policy may be undermined—parallels drawn to dollarization scenarios.
Monetary policy challenges and theoretical concerns
- Central banks typically conduct policy by setting short-term interest rates in interbank markets for reserves.
- Concern: losing monopoly supplier status of central bank reserves could impair ability to conduct monetary policy (King 1999).
- Debate points:
- Whether massive adjustments in central bank balance sheets would be necessary in a crypto-dominated world.
- Whether central bank interest rates would become disconnected from interest rates and asset prices that matter for ordinary transactions (Friedman 2000).
- Core question summarized: “The only real question about such a future is how much the central banks’ monetary policies would matter” (Woodford 2000).
Central bank responses and policy recommendations
- Continue to make fiat currencies better and more stable units of account:
- Modern monetary policy, monetary policy committees, and central bank independence remain central to maintaining stable units of account.
- Monetary policymaking can benefit from technology: big data, artificial intelligence, and machine learning can improve economic forecasts.
- Regulate crypto assets to prevent regulatory arbitrage and unfair competitive advantage:
- Rigorously apply measures to prevent money laundering and the financing of terrorism.
- Strengthen consumer protection.
- Effectively tax crypto transactions.
- Make central bank money attractive as a settlement vehicle:
- Consider issuing central bank digital currency (CBDC) as digital tokens to supplement physical cash and bank reserves.
- CBDC could be exchanged peer to peer in a decentralized manner, similar to crypto assets.
Central bank digital currency (CBDC) — trade-offs and potential benefits
- Potential benefits of CBDC:
- Counter monopoly power arising from network externalities of private payment networks.
- Reduce transaction costs for individuals and small businesses with limited or costly banking access.
- Enable long-distance transactions and remove denomination limits inherent in physical cash.
- Interest-carrying CBDC could help transmit policy interest rates when demand for reserves diminishes.
- Continued use of central bank liabilities could help central banks earn income from currency issuance, finance operations, and distribute profits to governments.
- For many emerging market and developing economies, seigniorage is the main source of revenue and an important safeguard of central bank independence.
- Design choices and risks:
- Need careful consideration to avoid increasing the risk of bank runs due to the convenience of digital cash.
- Views on benefits and risks will differ across countries depending on financial and technological development.
Conclusion — strategic stance for central banks
- Central banks face both challenges and opportunities in the digital age.
- To remain relevant, central banks must:
- Maintain public trust in fiat currencies.
- Provide more stable units of account than crypto assets.
- Make central bank money attractive as a medium of exchange in a digital, sharing, and decentralized service economy.
- Policy mix: effective monetary policy, appropriate regulation, and consideration of CBDC design to preserve monetary policy effectiveness and central bank independence.
References
- Friedman, Benjamin M. 2000. “Decoupling at the Margin: The Threat to Monetary Policy from the Electronic Revolution in Banking.” International Finance 3 (2): 261–72.
- Goodhart, Charles. 2000. “Can Central Banking Survive the IT Revolution?” International Finance 3 (2): 189–209.
- He, Dong, Ross Leckow, Vikram Haksar, Tommaso Mancini Griffoli, Nigel Jenkinson, Mikari Kashima, Tanai Khiaonarong, Céline Rochon, and Hervé Tourpe. 2017. “Fintech and Financial Services: Initial Considerations.” IMF Staff Discussion Note 17/05, International Monetary Fund, Washington, DC.
- King, Mervyn. 1999. “Challenges for Monetary Policy: New and Old.” Speech delivered at a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, WY, August 27.
- Woodford, Michael. 2000. “Monetary Policy in a World without Money.” International Finance 3 (2): 229–60.
Source: Central Bank Monetary Policy in the Age of Cryptocurrencies — F&D Magazine, June 2018, DONG HE.
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