Digital money, a curiosity just a few years ago, is becoming an intense concern for central banks with the potential to erode the power of monetary policy and likely make interest rate control more difficult even in the best of all worlds, according to new Federal Reserve and other research.
The New York Fed Symposium has highlighted the conundrum central bankers face in dealing with emerging digital technologies, ranging from new ways of processing payments to new asset classes like cryptocurrencies and stablecoins.
The underlying technology is showing benefits, including better transaction speeds, lower costs and easier access to banking services, and even with the recent meltdowns and volatility, it is expected to continue to advance.
In other words, ignore it, and systems developed by burgeoning private companies could capture larger funding shares and make “funded money” less relevant – reducing the central bank’s control over interest rates.
Create a replacement in the form of a central bank digital currency and new instabilities could emerge – including the potential for a digital dollar or euro to replace traditional bank deposits and compete with money market funds and other major financial instruments.
In a crisis, the process could mimic a bank run, starving the system for liquidity and forcing the Fed, for example, to either increase lending to commercial banks or increase its own holdings of government bonds and similar securities to keep the system stable.
Banks losing deposits would have to compete for new ones, and “depending on the intensity…the general level of short-term interest rates…could rise,” concluded a Fed paper outlining possible outcomes should the Federal Reserve launch a retail-level digital currency, open to households.
The Fed, like most central banks around the world, is debating whether to develop a digital currency. A decision has not yet been made, and officials say it needs congressional approval to move forward.
The point of tension may seem far away as the market value of cryptocurrencies and stablecoins remains a small part of the financial system. But payment processors like PayPal and Apple Pay are growing fast, processing transactions on the scale of large credit card companies earlier this year.
Among cryptocurrencies and stablecoins, the New York conference noted, some of the arrangements involve exotic credit schemes — credit creation — which, if expanded, could entail greater risks.
“What if the central bank runs out of relevant money, either at the retail or wholesale level? In that case, the central bank could lose traction,” said Eswar Prasad, a Cornell University professor and author of the recent book, in his monetary policy The future of money on the topic said on the sidelines of the conference.
“It is becoming a problem in some countries today. China, increasingly India or Sweden – the use of central bank money in retail payments has dropped to “virtually zero” as private payment providers jumped in.
The impact of central bank digital currencies on monetary policy is just part of a broader view by institutions like the Fed of how new technologies will transform the financial system.
As these technologies have gained prominence, the impact on financial stability and the risks to individual investors have become a higher priority for research and regulation.
In the United States, President Joe Biden issued an ordinance to regulate the industry, citing growth in crypto assets from $14 billion to 3 trillion over five years.
Central banks around the world are quickly stepping off the sidelines in the face of the stakes. A Bank for International Settlements survey of 81 central banks in countries that account for almost all of global economic output, released last month, found that more than 90 percent are exploring the idea of a central bank digital currency.
More than a quarter are either actively developing a digital currency or running pilot programs, a share that has nearly doubled from 2020 to 2021. The explosion of electronic payments as well as crypto investing during the pandemic is speeding up work, respondents said, with about 60 percent of banks saying cash use is declining.
https://www.independent.ie/business/world/central-banks-brace-for-crypto-storm-41720377.html Central banks prepare for “crypto storm”.