Category Archives: Contributions

“Libra Paves the Way for Central Bank Digital Currency,” finews and WNM, 2019

My VoxEU column now also on finews and World News Monitor, September 17, 2019.

Digital currencies involve tradeoffs. Libra resolves them less favorably than other projects, and less favorably than CBDC.

When confronted with the choice between the status quo and a new financial architecture with CBDC, most central banks have responded cautiously. But Libra or its next best replica will take this choice off the table – the status quo ceases to be an option. The new choice for monetary authorities and regulators will be one between central bank managed CBDC on the one hand and – riskier – private digital tokens on the other. Central banks have a strong interest to maintain control over the payment system as well as the financial sector more broadly and to defend the attractiveness of their home currency. Nolens volens, they will therefore introduce ‘Reserves for All’ or promote synthetic CBDCs. In economics, things take longer than one thinks they will, as Rudi Dornbusch quipped, but then they happen faster than one thought they could.

“Libra Paves the Way for Central Bank Digital Currency,” VoxEU, 2019

VoxEU, September 12, 2019. HTML.

Digital currencies involve tradeoffs. Libra resolves them less favorably than other projects, and less favorably than CBDC.

When confronted with the choice between the status quo and a new financial architecture with CBDC, most central banks have responded cautiously. But Libra or its next best replica will take this choice off the table – the status quo ceases to be an option. The new choice for monetary authorities and regulators will be one between central bank managed CBDC on the one hand and – riskier – private digital tokens on the other. Central banks have a strong interest to maintain control over the payment system as well as the financial sector more broadly and to defend the attractiveness of their home currency. Nolens volens, they will therefore introduce ‘Reserves for All’ or promote synthetic CBDCs. In economics, things take longer than one thinks they will, as Rudi Dornbusch quipped, but then they happen faster than one thought they could.

Views on Libra

Different aspects of the Libra proposal that various authors have emphasized:

  • Jameson Lopp on OneZero: A “database of programmable resources;” Move; “[p]erhaps the network as a whole can switch to proof of stake, but in order for the stablecoin peg/basket to be maintained, some set of entities must keep a bridge open to the traditional financial system. This will be a persistent point of centralized control via the Libra Association”; not a blockchain, the “data structure of the ledger history is a set of signed ledger states”; initially, 1,000 payment transactions per second with a 10-second finality time; technical aspects.
  • Laura Noonan and Nicholas Megaw in the FT: Gaining regulatory approval (in each US state, as well as in many countries) is burdensome even if Carney signals “open mind but not open door”; ING declined to be part of consortium; how can merchants be brought onboard?
  • James Hamilton on Econbrowser: Currency board; currency competition.
  • JP Koning on Moneyness: Competition for national banking systems; new unit of account; global monies (or languages) never worked out.
  • Stephen Williamson on New Monetarism: Narrow bank or mutual fund; why “krypto” or “blockchain?” [T]ere’s never been a successful banking system that didn’t have a strong regulatory hand behind it.
  • Corinne Zellweger-Gutknecht and Dirk Niepelt in NZZ, Jusletter: Role of resellers; regulation in Switzerland.
  • Kari Paul in the Guardian: Astrology.

“Libra oder lieber nicht? (Libra, or Better Not?),” NZZ, 2019

NZZ, 10 July 2019, with Corinne Zellweger-Gutknecht. PDF.

Libra is supposed to be backed; the returns on the securities backing it are going to be distributed among the Libra partners; and Libra’s price is supposed to be managed by a network of market makers. We don’t know much more. Will market makers have the incentive to deliver?

See also the longer article in Jusletter.

“Das Geschäftsmodell hinter Libra (Libra’s Business Model),” Jusletter, 2019

Jusletter, 1 July 2019, with Corinne Zellweger-Gutknecht. PDF.

Libra is supposed to be backed; the returns on the securities backing it are going to be distributed among the Libra partners; and Libra’s price is supposed to be managed by a network of market makers. We don’t know much more. Will market makers have the incentive to deliver?

“Digitales Zentralbankgeld (Central Bank Digital Currency),” FuW, 2019

Finanz und Wirtschaft, June 29, 2019. PDF. Related article in Oekonomenstimme, July 9, 2019. HTML.

    • It is not central bank digital currency (CBDC) per se which might act as a game changer in financial markets. What will be key is how central banks accommodate the introduction of CBDC.
    • In principle, this accommodation can go very far, to the point where the introduction of CBDC does not affect macroeconomic outcomes.
    • But such complete accommodation is unlikely. On the one hand, central banks will want to exploit the new monetary policy options that CBDC opens up; that is, central banks will not choose to fully accommodate.
    • On the other hand, the introduction of CBDC increases transparency and this will increase political pressure; as a consequence, central banks will not be able to fully accommodate.

The Future of Money – CBDC and Beyond

At the conference of “Positiva Pengar” and “Monetative” in Stockholm, I argued that it is not so much the introduction of CBDC which would make a difference, but the policies accompanying such an introduction. This view is backed by research of Markus Brunnermeier and myself, as well as by myself.

Many of the proponents of the sovereign money movement appeared open to the argument. Some of the followers, however, did not; they associate CBDC with many benefits that money, in whatever form, will not be able to deliver.

“Moderne monetäre Theorie: Ein makroökonomisches Perpetuum mobile (The Macroeconomic Perpetuum Mobile),” NZZ, 2019

NZZ, April 25, 2019. PDF.

  • Modern monetary theory (MMT) is neither a theory, nor modern, nor exclusively monetary.
  • I discuss fallacies related to MMT.
  • Dynamic inefficiency requires permanent, not transitory, r<g.
  • For now, policy makers should rely on common sense rather than MMT.

“Public versus Private Digital Money: Macroeconomic (Ir)relevance,” VoxEU, 2019

VoxEU, March 20, 2019, with Markus Brunnermeier. HTML.

Both proponents and opponents have suggested that CBDC would fundamentally change the macroeconomy, either for the better or the worse. We question this paradigm. We derive an equivalence result according to which the introduction of CBDC need not alter the allocation nor the price system. And we argue that key concerns put forward in discussions about CBDC are misplaced.

See also our VoxEU book chapter and my paper from last year.

“Die SNB schuldet den Pensionskassen nichts (Nothing the SNB Owes to Pension Funds),” NZZ, 2019

NZZ, March 13, 2019. PDF. Updated: Ökonomenstimme, March 22, 2019. HTML.

  • Long-term real interest rates do not reflect monetary policy.
  • In the recent past, monetary policy has contributed to lower fixed-income interest rates but also to higher returns on other asset classes.
  • Complaining about low rates but not adjusting one’s portfolio makes little sense; there is no “financial repression.”
  • If politicians want to subsidize pension funds they should contribute funds from the government budget rather than asking the central bank to contribute.
  • Larger and earlier SNB dividend payouts to the government may not be in the government’s interest.

“Reserves For All? Central Bank Digital Currency, Deposits, and their (Non)-Equivalence,” IJCB

Accepted for publication in the International Journal of Central Banking. PDF.

This paper offers a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public hold electronic central bank money and transact with it. I propose an equivalence result according to which a marginal substitution of outside money (e.g., RFA) for inside money (e.g., deposits) does not affect macroeconomic outcomes. I identify key conditions for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate the analysis to common arguments found in discussions on RFA and point to inconsistencies and open questions.

“Digital Money: Private versus Public,” VoxEU Book, 2019

In Antonio Fatás, editor, The Economics of Fintech and Digital Currencies, VoxEU book, London, March 2019, with Markus Brunnermeier. PDF.

We address five key concerns that are frequently put forward:
1. Aren’t digital currencies just a hype, now that crypto ‘currencies’ like Bitcoin have proved too volatile and expensive to serve as reliable stores of value or mediums of exchange? This confuses things. A central bank digital currency (CBDC) is like cash, only digital; Alipay, Apple Pay, WeChat Pay, and so on are like deposits, only handier; and crypto currencies are not in any way linked to typical currencies, but they live on the blockchain.
2. Doesn’t a CBDC or ‘Reserves for All’ choke investment by cutting into bank deposits? No, because new central bank liabilities (namely, a CBDC) would fund new investments, and this would not in any way imply socialism or a stronger role of government in investment decisions.
3. Wouldn’t a CBDC cut into the profits that banks generate by creating deposits? Less money creation by banks would certainly affect their profits. But if this were deemed undesirable (by the public, not by shareholders and management) then banks could be compensated.
4. Wouldn’t ‘Reserves for All’ render bank runs more likely, undermining financial stability? We argue that, in fact, the opposite seems more plausible.
5. Aren’t deposit insurance, a CBDC, Vollgeld/sovereign money, and the Chicago Plan all alike? There are indeed close parallels between the different monetary regimes. In a sense, “money is changing and yet, it stays the same”.

Arnold Kling’s “Specialization and Trade, A Re-Introduction to Economics”

Arnold Kling (2016), Specialization and Trade, A Re-Introduction to Economics, Washington, DC, Cato Institute.

Kling’s central theme in this short book of nine main chapters is that specialization, trade, and the coordination of individual plans by means of the price system and the profit motive play fundamental roles in modern economies. Most mainstream economists would agree with this assessment. Their models of trade, growth, and innovation certainly include the four elements, with varying emphasis.

But Kling criticizes the methodological approach adopted by post-world-war-II economics, which he associates with “MIT economics.” An MIT PhD himself, he argues that economics, and specifically macroeconomics, should adopt less of a mechanistic and more of an evolutionary perspective to gain relevance. In the second chapter, entitled “Machine as Metaphor,” Kling asserts that under the leadership of Paul Samuelson post-war (macro)economics framed economic issues as programming problems that resemble resource allocation problems in a wartime economy. Even as the discipline evolved, Kling contends, the methodology remained the same, pretending controllability by economist-engineers; in the process, the role of specialization was sidelined in the analysis.

I think that Kling is too harsh in his assessment. Economics and macroeconomics, in particular, has changed dramatically since the times of Paul Samuelson. The notion that, given enough instruments, any economic problem can be solved as easily as a system of equations, has lost attraction. Modern macroeconomic models are based on microeconomic primitives; they take gains from trade seriously; they involve expectations and frictions; and they do not suggest easy answers. The task of modern macroeconomics is not to spit out a roadmap for the economist-engineer but to understand mechanisms and identify problems that arise from misaligned incentives.

Kling is right, of course, when he argues that many theoretical models are too simplistic to be taken at face value. But this is not a critique against economic research which must focus and abstract in order to clarify. It rather is a critique against professional policy advisors and forecasters, “economic experts” say. These “experts” face the difficult task of surveying the vast variety of mechanisms identified by academic research and to apply judgement when weighing their relevance for a particular real-world setting. To be useful, “experts” must not rely on a single framework and extrapolation. Instead, they must base their analysis on a wide set of frameworks to gain independent perspectives on a question of interest.

In chapters three to five, Kling discusses in more detail the interplay of myriads of specialized trading partners in a market economy and how prices and the profit motive orchestrate it. In the chapter entitled “Instructions and Incentives,” Kling emphasizes that prices signal scarcity and opportunity costs are subjective. In the chapter entitled “Choices and Commands,” he discusses that command-and-control approaches to organizing a society face information, incentive, and innovation problems, unlike approaches that rely on a functioning price mechanism. And in the chapter “Specialization and Sustainability,” Kling makes the point that well-defined property rights and a functioning price mechanism offer the best possible protection for scarce resources and a guarantee for their efficient use. Sustainability additionally requires mechanisms to secure intergenerational equity.

I agree with Kling’s point that we should be humble when assessing whether market prices, which reflect the interplay of countless actors, are “right” or “wrong.” However, I would probably be prepared more often than Kling to acknowledge market failures of the type that call for corrective taxes. The general point is that Kling’s views expressed in the three chapters seem entirely mainstream. While we may debate how often and strongly market prices fail to account for social costs and benefits, the economics profession widely agrees that for a price system to function well this precondition must be satisfied.

In the sixth chapter, entitled “Trade and Trust,” Kling argues that specialization rests on cultural evolution and learning and more broadly, that modern economic systems require institutions that promote trust. Independently of the norms a particular society adopts, it must implement the basic social rule,

[r]eward cooperators and punish defectors.

How this is achieved (even if it is against the short-run interest of an individual) varies. Incentive mechanisms may be built on the rule of law, religion, or reputation. And as Kling points out societies almost always rely on some form of government to implement the basic social rule. In turn, this creates problems of abuse of power as well as “deception” and “demonization.” Mainstream economists would agree. In fact, incentive and participation constraints, lack of commitment, enforcement, and self-enforcement are at center stage in many of their models of partial or general equilibrium. Similarly, the role of government, whether benevolent or representing the interests of lobby groups and elites, is a key theme in modern economics.

Chapter seven, entitled “Finance and Fluctuations,” deals with the role of the financial sector. Kling argues that finance is a key prerequisite for specialization and since trust is a prerequisite for finance, swings in trust—waves of optimism and pessimism—affect the economy. No mainstream macroeconomist will object to the notion that the financial sector can amplify shocks. Seminal articles (which all were published well before the most recent financial crisis) exactly make that point. But Kling is probably right that the profession’s workhorse models have not yet been able to incorporate moods, fads, and manias, the reputation of intermediaries, and the confidence of their clients in satisfactory and tractable ways, in spite of recent path-breaking work on the role of heterogenous beliefs.

In chapter eight, Kling focuses on “Policy in Practice.” He explains why identifying market failure in a model is not the same as convincingly arguing for government intervention, simply because first, the model may be wrong and second, there is no reason to expect government intervention to be frictionless. I don’t know any well-trained academic economist who would disagree with this assessment (but many “experts” who are very frighteningly confident about their level of understanding). The profession is well aware of the insights from Public Choice and Political Economics, although these insights might not be as widely taught as they deserve. And Kling is right that economists could explain better why real-world policy selection and implementation can give rise to new problems rather than solely focusing on the issue of how an ideal policy might improve outcomes.

To me, the most interesting chapters of the book are the first and the last, entitled “Filling in Frameworks” and “Macroeconomics and Misgivings,” respectively. In the first chapter, Kling discusses the difference between the natural sciences and economics. He distinguishes between scientific propositions, which a logical flaw or a contradictory experiment falsifies, and “interpretive frameworks” a.k.a. Kuhn’s paradigms, which cannot easily be falsified. Kling argues that

[i]n natural science, there are relatively many falsifiable propositions and relatively few attractive interpretive frameworks. In the social sciences, there are relatively many attractive interpretive frameworks and relatively few falsifiable propositions.

According to Kling, economic models are interpretative frameworks, not scientific propositions, because they incorporate a plethora of auxiliary assumptions and since experiments of the type run in the natural sciences are beyond reach in the social sciences. Anomalies or puzzles do not lead economists to reject their models right away as long as the latter remain useful paradigms to work with. And rightly so, according to Kling: For an interpretative framework with all its anomalies is less flawed than intuition which is uninformed by a framework. At the same time, economists should remain humble, acknowledge the risk of confirmation bias, and remain open to competing interpretative frameworks.

In the chapter entitled “Macroeconomics and Misgivings,” Kling criticizes macroeconomists’ reliance on models with a representative agent. I agree that representative agent models are irrelevant for applied questions when the model implications strongly depend on the assumption that households are literally alike, or that markets are complete such that heterogeneous agents can perfectly insure each other. When “experts” forecast macroeconomic outcomes based on models with a homogeneous household sector then these forecasts rest on very heroic assumptions, as any well-trained economist will readily acknowledge. Is this a problem for macroeconomics which, by the way, has made a lot of progress in modeling economies with heterogeneous agents and incomplete markets? I don’t think so. But it is a problem when “experts” use such inadequate models for policy advice.

Kling argues that the dynamic process of creative destruction that characterizes modern economies requires ongoing change in the patterns of specialization and trade and that this generates unemployment. Mainstream models of innovation and growth capture this process, at least partially; they explain how investment in new types of capital and “ideas” can generate growth and structural change. And the standard framework for modeling labor markets features churn and unemployment (as well as search and matching) although, admittedly, it does not contain a detailed description of the sources of churn. The difference between the mainstream’s and Kling’s view of how the macroeconomy operates thus appears to be a difference of degree rather than substance. And the difference between these views and existing models clearly also reflects the fact that modeling creative destruction and its consequences is difficult.

Kling is a sharp observer when he talks about the difference between “popular Keynesianism” and “rigor-seeking Keynesianism.” The former is what underlies the thinking of many policy makers, central bankers, or journalists: a blend of the aggregate-demand logic taught to undergraduates and some supply side elements. The latter is a tractable simplification of a micro-founded dynamic general equilibrium model with frictions whose properties resemble some key intuitions from popular Keynesianism.

The two forms of Keynesianism help support each other. Popular Keynesianism is useful for trying to convince the public that macroeconomists understand macroeconomic fluctuations and how to control them. Rigor-seeking Keynesianism is used to beat back objections raised by economists who are concerned with the ways in which Keynesianism deviates from standard economics, even though the internal obsessions of rigor-seeking Keynesianism have no traction with those making economic policy.

There is truth to this. But in my view, this critique does not undermine the academic, rigor-seeking type of Keynesianism while it should undermine our trust in “experts” who work with the popular sort which, as Kling explains, mostly is confusing for a trained economist.

In the end, Kling concludes that it is the basics that matter most:

[B]etter economic outcomes arise when patterns of sustainable specialization and trade are formed. … It requires the creative, decentralized, trial-and-error efforts of thousands of entrepreneurs and millions of households … Probably the best thing that the government can do to encourage new forms of specialization is to rethink existing policies that restrict competition, discourage innovation, and retard mobility.

This is a reasonable conclusion. But it is neither a falsifiable proposition nor an interpretive framework. It is the synthesis of many interpretive frameworks, weighed by Kling. In my own view, the weighting is based on too harsh an assessment according to which many modern macroeconomic models are irrelevant.

Kling’s criticism of contemporaneous macroeconomics reads like a criticism of the kind of macroeconomics still taught at the undergraduate level. But modern macroeconomics has moved on—it is general equilibrium microeconomics. Its primary objective is not to produce the one and only model for economist-engineers or “experts” to use, but rather to help us understand mechanisms. A good expert knows many models, is informed about institutions, and has the courage to judge which of the models (or mechanisms they identify) are the most relevant in a specific context. We don’t need a new macroeconomics. But maybe we need better “experts.”

JPM Coin

In the FT, Robert Armstrong reports about the new “JPM coin” launched by JP Morgan.

“JPM Coins” will be transferable over a blockchain between the accounts of the bank’s corporate clients, who will purchase and redeem them for dollars at a fixed 1:1 ratio, making them “stablecoins” in the crypto-jargon.

The technology will facilitate near-instantaneous settlement of these money transfers and will, according to the bank, mitigate counterparty risk.

According to my reading, the coins are essentially bank deposit that live on a blockchain which is managed by JP Morgan and accessible by the bank’s clients. I doubt that a coin will be redeemable for US dollars issued by the Federal Reserve (as opposed to deposits issued by JP Morgan).

“Mounting Pressure on Central Banks,” finews, 2018

finews.asia, December 27, 2018. HTML. finews.ch, December 27, 2018. HTML.

  • Independence has increasingly come under pressure and this pressure will remain. What has been tried and tested for years is now questioned again.
  • Increasing demands on central banks reflect the failure of other state organs.

“Central Bank Digital Currency: What Difference Does It Make?,” SUERF, 2018

December 2018. PDF. In: Ernest Gnan and Donato Masciandaro, editors, Do We Need Central Bank Digital Currency? Economics, Technology and Institutions, SUERF, The European Money and Finance Forum, Vienna, 2018.

A short version of the CEPR working paper.

TIPS Goes Online

The ECB launches its Target Instant Payment Settlement (TIPS) system, which facilitates instant money transfers between banks and allows end users connected to those banks to make instant retail payments across the Euro zone.

Report in the FAZ. Last year’s report by Mehreen Khan in the FT.

From the ECB’s website:

TIPS was developed as an extension of TARGET2 and settles payments in central bank money. TIPS currently only settles payment transfers in euro. However, in case of demand other currencies could be supported as well. …

… a number of national solutions have been developed, or are under development, across the EU. A challenge for the Eurosystem is to ensure that these national solutions do not (re)introduce fragmentation … TIPS aims to minimise this risk by offering a service that can help ensure that any bank account holder in Europe can be reached. …

Participating payment service providers can set aside part of their liquidity on a dedicated account opened with their respective central bank, from which instant payments can be settled. It is only possible to add funds to TIPS accounts during TARGET2 opening hours.

As settlement in TIPS takes place in central bank money, participation in TIPS depends on being eligible to access central bank money. For this reason, in order to open an account in TIPS in euro, an institution needs to fulfil the same eligibility criteria as for participation in TARGET2.

Banks pay at most 0.2 cent per transaction during the first two years of operation.

See also the blog post on the Bank of England’s related, but different “interledger” program.

Central bank digital currency gets closer by the day …

“Nicht-Wissen kann schützen (Knowing Less Protects),” FuW, 2018

Finanz und Wirtschaft, November 24, 2018. PDF. Ökonomenstimme, November 26, 2018. HTML.

  • European firms dealing with Iran face U.S. “secondary sanctions.”
  • European counter measures (including a blocking statute) prove toothless.
  • Even central banks in the European Union surrender to U.S. pressure, as does SWIFT.
  • Ignorance is bliss: For a sovereign, the best protection against foreign states pressuring to monitor domestic citizens and businesses may be to know as little as possible.

IMF’s Lagarde Open to CBDC

At a conference in Singapore, IMF Managing Director Christine Lagarde has argued that

[w]hile the case for digital currency is not universal, we should investigate it further, seriously, carefully and creatively.

In her speech she emphasizes potential benefits related to financial inclusion; security and consumer protection; and privacy. (Privacy would be limited however.) She sees risks as well, including to innovation. But she de-emphasizes the notion of increased run risk which commentators often stress.

What about the risk of bank runs? It exists. But consider that people run when they believe that cash withdraws are honored on a first-come-first-serve basis—the early bird gets the worm. Digital currency, instead, because it can be distributed much more easily than cash, could reassure even the person left lying on the couch!

In addition, if depositors are running to foreign assets, they will also shun the digital currency. And in many countries, there are already liquid and safe assets to run toward—think of mutual funds that only hold government bonds. So, the jury is still out on whether digital currencies would really upset financial stability.

She also refers to a recent IMF working paper on the subject.

The FT reports.

Almost all working papers on the subject of CBDC claim that the introduction of CBDC would change equilibrium outcomes. Very few papers carefully lay out the reasons; instead most papers make implicit assumptions that are not spelled out although they are crucial for the results. I have argued elsewhere (see this blog post) that the introduction of CBDC could leave equilibrium outcomes unchanged in a benchmark case, and with Markus Brunnermeier we have formally presented the argument.

“Reserves For All? …” on Several SSRN Top Ten Lists

My July 2018 CEPR working paper “Reserves For All? Central Bank Digital Currency, Deposits, and their (Non)-Equivalence” has made it on several SSRN top ten lists. PDF. (Personal copy.)

Abstract: I offer a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public use electronic central bank money. After distinguishing RFA from cryptocurrencies and relating the proposal to discussions about narrow banking and the abolition of cash I propose an equivalence result according to which a marginal substitution of outside for inside money does not affect macroeconomic outcomes. I identify key conditions on bank and government (central bank) incentives for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate my analysis to common arguments in the discussion about RFA and point to inconsistencies and open questions.