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11. The next generation of digital currencies: in search of stability

Author:
Gregory Claeys and Maria Demertzis
Publication Date:
12-2019
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
Four major developments have challenged the status quo and reopened the debate on the forms that money will take in the future: 1) use of cash as a medium of exchange has declined; 2) distributed ledger technology (DLT) has led to the emergence of thousands of digital cryptocurrencies; 3) some global tech giants are planning to provide private digital currencies to their billions of users in the form of stablecoins; and 4) in turn, public authorities are thinking about providing their own digital currencies to the general public. These developments raise questions about the implications for financial stability, the transmission of monetary policy and financial intermediation. This Policy Contribution focuses on the consequences stablecoins and central bank digital currencies could have. Stablecoins, such as Facebook’s Libra, differ from earlier generations of cryptocurrencies in three fundamental ways. First, they would start with large networks of users and global accessibility, two pivotal features for the critical uptake of a new currency. Second, given the current limitations of DLT, including in terms of energy efficiency, new stablecoins would rely on (more) centralised systems to validate transactions. Third, stablecoins would focus particularly on reducing the volatility in the value of the new currency. These new features of stablecoins attempt to correct some of the critical deficiencies identified in first-generation cryptocurrencies, which meant they did not acquire the main functions of money. However, new stablecoins raise other questions and potentially create new problems. One issue could arise from the more centralised (permissioned) validation system, which could lead to collusion problems. Another issue could arise from the reserve system that is supposed to ensure the stability of stablecoins, such as Libra, which could be incompatible with the profit maximisation behaviour of a private issuer. Facebook’s Libra plan has been a wake-up call to central banks and governments which, afraid of losing their monetary sovereignty, have renewed their interest in central bank digital currencies (CBDCs) as a potential solution. CBDCs could make private digital currencies less attractive and slow down their adoption. But there are other reasons to give the general public access to central bank liabilities. One important reason to provide CBDCs to citizens is that if cash disappears, citizens will lose direct access to sovereign money. Another benefit of the introduction of CBDCs is that monetary policy could be strengthened by transmitting it directly to the general public. However, the introduction of CBDCs could also be disruptive and create risks. In particular, CBDCs could have major consequences for financial intermediation. These risks would have to be evaluated by policymakers before any decisions are taken. If CBDCs are introduced, central banks would have to carefully calibrate their properties to minimise these risks. But, eventually, if these risks – and in particular the risk of structural financial disintermediation – do materialise, central banks would have various instruments to counter them.
Topic:
Science and Technology, Central Bank, Currency, Cryptocurrencies, and European Parliament
Political Geography:
Europe

12. The Function Transformation of Central Banks and Commercial Banks under the Application of Digital Fiat Currency

Author:
Song Shuang and Liu Dongmin
Publication Date:
04-2019
Content Type:
Policy Brief
Abstract:
Since the advent of Bitcoin, digital currency and its underlying distributed ledger technology have been spread and applied rapidly around the world. Traditionally, currency issuance and circulation are based on binary tree structure, with the central bank as the highest node, commercial banks in the middle and the public and enterprises at the bottom. However, in the distributed ledger system, all nodes have similar privileges and can transact with each other directly. Hence, the advocators promote the potential of digital currency to subvert the monetary control of sovereign countries and alter the traditional business of commercial banks with the characteristics of decentralization, trust-free intermediary, non-tampering and encryption security. On the other hand, the dissenters believe that transaction nodes in distributed ledger system will be greatly increased, and hence reducing the professionalism of transaction processing and forfeiting the authenticity of original information, which then becomes difficult to play a significant role in the future economy.
Topic:
Science and Technology, Economy, Banks, Central Bank, Currency, and Bitcoin
Political Geography:
China and Global Focus

13. Toward a Rules‐​Based International Monetary System

Author:
John B. Taylor
Publication Date:
06-2018
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
Over the past few years I have been making the case for moving toward a more rules-based international monetary system (e.g., Taylor 2013, 2014, 2015, 2016a, 2016b, 2017). In fact, I made the case over 30 years ago in Taylor (1985), and the ideas go back over 30 years before that to Milton Friedman (1953). However, the case for such a system is now much stronger because the monetary system drifted away from a rules-based approach in the past dozen years and, as Paul Volcker (2014) reminds us, the absence of a rulesbased monetary system “has not been a great success.” To bring recent experience to bear on the case, we must recognize that central banks have been using two separate monetary policy instruments in recent years: the policy interest rate and the size of the balance sheet, in which reserve balances play a key role. Any international monetary modeling framework used to assess or to make recommendations about international monetary policy must include both instruments in each country, the policy for changing the instruments, and the effect of these changes on exchange rates. Using such a framework, I show that both policy instruments have deviated from rules-based policy in recent years. I then draw the policy implications for the international monetary system and suggest a way forward to implement the policy.
Topic:
International Cooperation, International Trade and Finance, Monetary Policy, and Central Bank
Political Geography:
Global Focus

14. The Japanese Experience with QE and QQE

Author:
John Greenwood
Publication Date:
01-2017
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
This article provides an overview of the three episodes of quantitative easing (QE) pursued by the Bank of Japan (BOJ) since 2001. It begins with a brief account of the initial reluctant shift to unorthodox policies under BOJ Governors Hayami and Fukui in 2001–06 (here designated QE1) and then covers the equally reluctant adoption of QE by Governor Shirakawa in 2010–13 (QE2). The article then turns to an account of the attempt since April 2013 by the BOJ under Governor Kuroda, designated “quantitative and qualitative easing” (QQE), to revive the economy and achieve a 2 percent inflation target. None of these attempts at QE has been successful in raising the broad money growth rate for M2 sustainably above the 2–3 percent per annum range where it has languished for the past 25 years. Consequently, Japan’s attempts at QE have all failed to raise the equilibrium level of Japanese nominal GDP by any material magnitude, and so far, attainment of the 2 percent inflation target under QQE has remained elusive. At the time of writing (October 2016), the Japanese economy therefore continues to grow at a low rate with periodic lapses into deflation. After discussing the case of Japan, the article compares the experience of the United States in 1929–33, when there was no QE, and the experience of 2008–14, when the Fed conducted QE over three periods. The comparison is deliberately focused on the quantitative aspects of the policy, not its interest rate effects. Finally, the article explains that there are two brands of QE, and that the failure of QE in Japan is fundamentally due to the choice of the wrong brand of QE. Given the type of QE that the Japanese authorities have chosen, the policy cannot be expected to succeed, except under limited conditions.1 If QE were to be implemented according to a different design, the prospects of success would be much greater. In brief, the primary reason for the failure of BOJ-style QE or QQE derives from the habitual tendency to buy securities from banks instead of from nonbank private-sector entities (such as nonbank financial firms, nonfinancial firms, households, or foreigners). While QE policy in Japan boosts the monetary base, it does not increase broad money. But it is broad money that drives nominal GDP, not the monetary base.
Topic:
History, Economy, Banks, and Central Bank
Political Geography:
Japan and Asia

15. Towards An Inflation Targeting Regime in Zambia

Author:
Caesar Cheelo and Thulani Banda
Publication Date:
06-2017
Content Type:
Working Paper
Institution:
Zambia Institute for Policy Analysis and Research (ZIPAR)
Abstract:
In this paper, I seek to discuss the conduct of monetary policy in an inflation targeting framework. The objective is to understand structural and institutional nuances in settings where this framework is successful in controlling inflation and challenges that emerge in the implementation of inflation targeting. I deal with the question: which institutional conditions should exist to support the successful implementation of inflation targeting in countries that use it? I find several institutional and legal elements which are common and can potentially explain much of the success in the implementation of inflation targeting among their monetary authorities. I benchmark these elements with the concepts of transparency and accountability of the central bank which are central tenets in the discussion of inflation targeting. I note that central bank credibility is a key outstanding element in explaining the success of inflation targeting. Components such as central bank independence and commitment to low stable inflation as the overriding objective of monetary policy represent critical preconditions for inflation targeting and can sustain the credibility of monetary policy.
Topic:
Monetary Policy, Inflation, Central Bank, Transparency, and Financial Institutions
Political Geography:
Africa and Zambia

16. The Best of Rules and Discretion: A Case for Nominal GDP Targeting in India

Author:
Pranjul Bhandari and Jeffrey Frankel
Publication Date:
07-2014
Content Type:
Working Paper
Institution:
The John F. Kennedy School of Government at Harvard University
Abstract:
The recent revival of interest in nominal GDP (NGDP) targeting has come in the context of large advanced economies. We argue that the case for NGDP targeting is even more appealing for mid-sized developing countries, because they tend to be more susceptible to supply shocks and terms of trade shocks. For India, in particular, one major exogenous supply shock is the monsoon rains. NGDP targeting splits the impact of supply shocks automatically between inflation and real GDP growth. In the case of inflation targeting (IT), by contrast, the full impact of an adverse supply shock or terms of trade shock is felt as a loss in real GDP alone. NGDP targeting arguably achieves the best of both worlds: it automatically accommodates supply shocks as most central banks with discretion would do anyway, while retaining the advantage of anchoring expectations as rules are designed to do. We outline a simple theoretical model and derive the conditions under which an NGDP targeting regime would dominate other regimes such as IT for achieving objectives of output and price stability. We go on to estimate for the case of India the main parameters needed to ascertain whether these conditions hold, most notably the slope of the aggregate supply curve. We find that under certain plausible conditions, nominal GDP targeting is indeed better placed than IT, especially in the face of the supply shocks that developing countries tend to experience.
Topic:
Development, Emerging Markets, Monetary Policy, GDP, Inflation, and Central Bank
Political Geography:
South Asia and India

17. Interest on Excess Reserves as a Monetary Policy Instrument: The Experience of Foreign Central Banks

Author:
David Bowman, Etienne Gagnon, and Mike Leahy
Publication Date:
03-2010
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper reviews the experience of eight major foreign central banks with policy interest rates comparable to the interest rate on excess reserves paid by the Federal Reserve. We pursue two main lines of inquiry: 1) To what extent have these policy interest rates been lower bounds for short-term market rates, and 2) to what extent has tightening that included increasing these policy rates been achieved without reliance on reductions in reserves or other deposits held at the central bank? The foreign experience suggests that policy rate floors can be effective lower bounds for market rates, although incomplete access to central bank accounts and interest on them weakens this result. In addition, the foreign experience suggests that tightening by increasing the interest rate paid on central bank balances can help reduce or eliminate the need to drain balances. These results are consistent with theoretical results that show that tightening without draining is possible, irrespective of whether excess reserves are large or small.
Topic:
Markets, Interest Rates, Central Bank, and Fiscal Policy
Political Geography:
Global Focus

18. The Macroeconomic Effects of External Pressures on Monetary Policy

Author:
Davide Debortoli and Ricardo Nunes
Publication Date:
09-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Central banks, whether independent or not, may occasionally be subject to external pressures to change policy objectives. We analyze the optimal response of central banks to such pressures and the resulting macroeconomic consequences. We consider several alternative scenarios regarding policy ob- jectives, the degree of commitment and the timing of external pressures. The possibility to adopt “more liberal” objectives in the future increases current inflation through an accommodation effect. Simultaneously, the central bank tries to anchor inflation by promising to be even “more conservative” in the future. The immediate effect is an output contraction, the opposite of what the pressures to adopt “more liberal” objectives may be aiming. We also discuss the opposite case, where objectives may become “more conservative” in the future, which may be the relevant case for countries considering the adoption of inflation targeting.
Topic:
Finance, Banks, Inflation, and Central Bank
Political Geography:
Global Focus