Category Archives: Notes

The Bank of England Welcomes Fintech

In the FT, Chris Giles, Caroline Binham, and Delphine Strauss report about plans of the Bank of England to let fintech companies

bank at Threadneedle Street and thereby offer payments systems on a level playing field with commercial banks.

The editorial board of the FT welcomes the plans; it seems to have in mind not only competition but also “synthetic” CBDC:

By offering fintech companies access to the BoE’s vaults, the governor may inject much-needed competition into the sector. What must follow is proactive regulation …

Commercial banks have traditionally had exclusive access to deposits at the UK’s central bank, offering them a competitive advantage through cheap banking services. … Another potential advantage for consumers is they could be paid the central bank’s often favourable interest rate directly — rather than relying on traditional banks to pass on rate rises.

Mark Carney outlined the plans in his Mansion House speech. Here are some excerpts from the section on digital finance:

… the Faster Payment System (FPS) launched a decade ago has made payments quicker (within two hours) and more cost effective by encouraging direct bank-to-bank transfers.

While mobile app PayM uses FPS to facilitate direct bank-to-bank payments between individuals via text, it requires both the sender and recipient to be signed up to the third party service. But few are. And FPS is not yet used for in-store or online purchases as the infrastructure required at the point of sale does not reliably exist in the UK.

In these regards, the UK is still a long way behind countries such as Sweden, the Netherlands and India …

The revolution of payments may not be driven by the old bank-based systems … Major changes are on the horizon … That’s why the Bank fully supports the Payments Strategy Review the Chancellor has launched this evening.

To support private innovation and to empower competition, the Bank is levelling the playing field between old and new. This means allowing competitors access to the same resources as incumbents while holding the same risks to the same standards.

… we are now making it easier for a broad set of firms to plug in and compete with more traditional providers. In July 2017, we became the first G7 central bank to open up access to our payment services to a new generation of non-bank PSPs. …

Responding to demands from innovators, the RTGS rebuild will also now provide API access to users to read and write payments data, as well as implementing a system whereby each payment will be tagged with information in a standardised format across the world. This global messaging standard will speed up settlement both domestically and across borders.

… Today, the Bank of England is announcing plans to consult on opening access to our balance sheet to new payment providers. Historically, only commercial banks were able to hold interest-bearing deposits, or reserves, at the Bank. …

From the Bank’s perspective, expanding access can improve the transmission of monetary policy and increase competition. It can also support financial stability by allowing settlement in the ultimate risk free asset, and reducing reliance on major banks. Users should benefit from the reduced costs and increased certainty that comes with banking at the central bank. …

This access could empower a host of new innovation. … settlement systems using distributed ledger technology … consortia, such as USC, propose to issue digital tokens that are fully backed by central bank money, allowing instant settlement. This could also plug into ‘tokenised assets’ – conventional securities also represented on blockchain—and smart contracts. This can drive efficiency and resilience in operational processes and reduce counterparty risks in the system, unlocking billions of pounds in capital and liquidity that can be put to more productive uses.

The potential transformation in retail payments is even more fundamental. …

The Bank of England approaches Libra with an open mind but not an open door. Unlike social media for which standards and regulations are being debated well after they have been adopted by billions of users, the terms of engagement for innovations such as Libra must be adopted in advance of any launch.

Carney also outlines plans to support initiatives that aim at giving households and firms control over “their” data:

To make real inroads, SMEs must be able to identify the data relevant to their businesses, incorporate it into their individual credit files, and easily share these files with potential providers of finance through a national SME financing platform.

This would put into practice the recommendations from Professor Jason Furman’s Digital Competition Panel report on how to extract value from data and promote competition. One of the most important recommendations in this regard is to give consumers control of their data. This would allow consumers to move their personal information from one platform to another and avoid lock-in effects, opening the door to new services. To some extent, this is what Open Banking hopes to achieve. Although to make this a success means establishing common off the-shelf API standards and operating platforms onto which developers can build. …

It is not for the Bank of England to build this platform but we can help lay some of groundwork. The messaging standards we are adopting in the new RTGS will also include tagging payments with a unique ID called a Legal Entity Identifier (LEI).

Link to earlier post on the SNB’s policy.

Libra

In the FT, Hannah Murphy reports about Facebook’s launch of Libra.

Lots of skepticism in the comments section.

And Hannah Murphy reports that

[p]ositive Money, a consumer campaign group, attacked the proposal. “Our money is increasingly in the hands of a small number of banks and payment companies, and we should avoid ceding further control to unaccountable corporate interests. Facebook’s plans pose alarming implications for privacy and power in the economy,” said David Clarke, the head of policy at the group.

Climate Risk, Credit Risk, and ECB Collateral

In a CEP Discussion Note, Pierre Monnin argues that financial markets mis-price climate related credit risk. If this were corrected some securities held by the ECB would loose their investment grade credit rating.

Assessing climate risks requires methodologies based on forward-looking scenarios, on complex cause-and-effect linkages and on data that has not been observed in the past. Such models are at their infancy, but already offer meaningful insights. This note provides an overview of key components that such models are built on and illustrates them with examples of the analytics that are already available. It also applies one of the available methodologies to assess transition risk to the corporate bond holdings of the European Central Bank.

Yuval Noah Harari’s “Sapiens—A Brief History of Humankind”

Homo appeared roughly 2 million years ago in Africa and Homo sapiens roughly 200’000 years ago in East Africa. Harari divides his account of the last 70’000 years into four parts: The cognitive revolution (language), the agricultural revolution (about 10’000 years ago in today’s Turkey, Iran, Levant), the unification of humankind (through money, empire, and religion), and the scientific revolution. According to Harari, Sapiens developed more efficient strategies for cooperation than other species and in particular, Neanderthals (which sapiens eradicated around 30’000 years ago). The rest is history, i.e., evolutionary biology and cultural history.

On his website, Harari summarizes:

Homo sapiens rules the world because it is the only animal that can believe in things that exist purely in its own imagination, such as gods, states, money and human rights.

Starting from this provocative idea, Sapiens goes on to retell the history of our species from a completely fresh perspective. It explains that money is the most pluralistic system of mutual trust ever devised; that capitalism is the most successful religion ever invented; that the treatment of animals in modern agriculture is probably the worst crime in history; and that even though we are far more powerful than our ancient ancestors, we aren’t much happier.

According to Harari, the agricultural revolution fostered population growth but made life harsher for most humans (due to less varied diet, harder work, infectious diseases)—and for the animals that Sapiens domesticated; religion, empires, money and trade fostered globalization and unification; the scientific revolution arose from Europeans’ admission of ignorance, and it was intertwined with imperialism and capitalism; whether humankind has become happier over time is unknown but doubtful; and we may soon confront a singularity:

Physicists define the Big Bang as a singularity. It is a point at which all the known laws of nature did not exist. Time too did not exist. It is thus meaningless to say that anything existed `before’ the Big Bang. We may be fast approaching a new singularity, when all the concepts that give meaning to our world—me, you, men, women, love and hate—will become irrelevant. Anything happening beyond that point is meaningless to us (p. 461 in the Vintage 2015 edition).

Other tidbits:

  • Settlement of Australia (“The Flood”), America, New Zealand: 45’000, 16’000, 800 years ago. Each settlement was associated with mass extinction of species.
  • “[F]iction has enabled us not merely to imagine things, but to do so collectively” (p. 27). “Ever since the Cognitive Revolution Homo sapiens has been able to revise its behaviour rapidly in accordance with changing needs. This opened a fast lane of cultural evolution, bypassing the traffic jams of genetic evolution.” (p. 36).
  • “The Agricultural Revolution was history’s greatest fraud. … These plants domesticated Homo sapiens, rather than vice versa” (p. 90). The revolution bred worries about the future. Food surpluses brought rulers and elites, palaces and temples, politics, wars, art and philosophy (p. 114). One `imagined order’ with three classes and two genders—the Code of Hammurabi—dates from 1’776 B.C. (p. 117). Writing, archiving, cataloguing (invented by Sumerians around 3’500 B.C.) preserves information about imagined social order; this is critical because the information is not preserved in DNA. Script undermined holistic thought. Hindus invented `Arab’ numerals around 800 AD (pp. 137–146).
  • Cognitive dissonance, contradictory beliefs are necessary to maintain any human culture (p. 184). Over the last 10’000 years, thousands of `human worlds’ have collapsed to a single one (p. 186). Three universal (imagined) orders: Money, empire, religion (p. 191). “Money is the most universal and most efficient system of mutual trust ever devised” (p. 201). Empires are stable, inclusive, not that bad (p. 219). Religious norms are founded on a belief in a superhuman order (p. 234). “Much of ancient mythology is in fact a legal contract in which humans promise everlasting devotion to the gods in exchange for mastery over plants and animals” (p. 236). Polytheist and animist religions recognize a supreme power in the background, devoid of biases and interests (p. 238). Humanist religions worship Homo sapiens. Liberal humanism believes in the humanity of the individual. Socialist humanism believes in the humanity of the collective. (Both build on Christian tradition). Evolutionary humanism (e.g., Nazism) believes that humankind can evolve or degenerate  (pp. 256–263).
  • Science started from the admission of ignorance; observation and math; and the acquisition of new powers (p. 279). Social stability requires that certain `scientific results’ are a dogma or that basic truths are non-scientific (p. 282). With the capitalist system and the industrial revolution, science, industry and military technology intertwined (p. 294). “[S]cientific research can flourish only in alliance with some religion or ideology. The ideology justifies the costs of the research” (p. 305). Science and empire supported each other (ch. 15, 16). The scientific revolution and the idea of progress fostered credit; this reinforced each other (p. 346). The industrial revolution has been a revolution in energy conversion (p. 379) and it was a second agricultural revolution (p. 382). Animal suffering, consumerism (ch. 17). The national time (p. 396). State and market replace family and local community (p. 398). “The state and the market are the mother and the father of the individual” (p. 402). “The nation is the imagined community of the state” (p. 406). The world is safer than ever, and war does not pay any more. Have humans become happier? Answer 1: “Lasting happiness comes only from serotonin, dopamine and oxytocin” (p. 436). Answer 2: Meaning. But “[p]erhaps happiness is synchronising one’s personal delusions of meaning with the prevailing collective delusions” (p. 438). Answer 3: Feelings are not to be trusted; of key import is whether people know the truth about themselves (p. 443). Intelligent design and extreme inequality (ch. 20).

Wikipedia points to critical scholarly reception.

Jack Kerouac’s “On the Road”

280 pages of frantic search for an end. New York, Denver, San Francisco, New Orleans, Mexico City, and the miles in between. Music, drugs, talk, sex.

Wikipedia:

Inspired by a 10000-word rambling letter from his friend Neal Cassady, Kerouac in 1950 outlined the “Essentials of Spontaneous Prose” and decided to tell the story of his years on the road with Cassady as if writing a letter to a friend in a form that reflected the improvisational fluidity of jazz. In a letter to a student in 1961, Kerouac wrote: “Dean and I were embarked on a journey through post-Whitman America to find that America and to find the inherent goodness in American man. It was really a story about 2 Catholic buddies roaming the country in search of God. And we found him.”

Objective Reality? Refuted

MIT Technology Review reports about the results of an experiment (arxiv.org/abs/1902.05080: Experimental Rejection of Observer-Independence in the Quantum World) suggesting that objective reality … does not exist.

The experiment produces an unambiguous result. It turns out that both realities can coexist even though they produce irreconcilable outcomes, just as Wigner predicted.

That raises some fascinating questions that are forcing physicists to reconsider the nature of reality.

The idea that observers can ultimately reconcile their measurements of some kind of fundamental reality is based on several assumptions. The first is that universal facts actually exist and that observers can agree on them.

But there are other assumptions too. One is that observers have the freedom to make whatever observations they want. And another is that the choices one observer makes do not influence the choices other observers make—an assumption that physicists call locality.

If there is an objective reality that everyone can agree on, then these assumptions all hold.

But Proietti and co’s result suggests that objective reality does not exist. In other words, the experiment suggests that one or more of the assumptions—the idea that there is a reality we can agree on, the idea that we have freedom of choice, or the idea of locality—must be wrong.

Of course, there is another way out for those hanging on to the conventional view of reality. This is that there is some other loophole that the experimenters have overlooked. Indeed, physicists have tried to close loopholes in similar experiments for years, although they concede that it may never be possible to close them all.

Nevertheless, the work has important implications for the work of scientists. “The scientific method relies on facts, established through repeated measurements and agreed upon universally, independently of who observed them,” say Proietti and co. And yet in the same paper, they undermine this idea, perhaps fatally.

The Board of Governors Prepares to Fight ‘The Narrow Bank’

The Board of Governors of the Federal Reserve System is requesting comment on the proposal to lower the interest rate on excess balances of eligible institutions that hold a very large proportion of their assets in the form of reserves—i.e., on balances of ‘The Narrow Bank.’

The document states that

[t]he Board is concerned that [Pass-Through Investment Entities] PTIEs, by maintaining all or substantially all of their assets in the form of balances at Reserve Banks and having the ability to attract very large quantities of deposits at a near-IOER rate, have the potential to complicate the implementation of monetary policy.

Fed Balance Sheet Policy and Collateral

On his blog, Stephen Williamson discusses the Fed’s plan to maintain a much larger balance sheet in the future than before the crisis. He is not convinced that this plan is a good one.

But what’s the harm in a large Fed balance sheet? The larger the balance sheet, the lower is the quantity of Treasury securities in financial markets, and the higher is reserves. Treasuries are highly liquid, widely-traded securities that play a key role in overnight repo markets. Reserves are highly liquid – for the institutions that hold them – but they are held only by a subset of financial institutions. Thus, a large Fed balance sheet could harm the operation of financial markets. … it would be reflected in a scarcity of collateral in overnight financial markets – in market interest rates. Before early 2018, T-bill rates and repo rates tended to be lower than the fed funds rate, and the fed funds rate was lower than IOER. Now, all those rates are about the same. The Fed thinks the difference is more Treasury debt, but I think the end of the Fed’s reinvestment program mattered, in that it increased the stock of on-the-run Treasuries. Whichever it was, apparently the quantity of Treasuries outstanding matters for the smooth – indeed, efficient – operation of financial markets, and the Fed should not mess with that. My prediction would be that, if we get to the end of the year and the Fed is again buying Treasuries, that we’ll see repo rates and T-bill rates dropping below IOER. Watch for that.

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).

Why Did Swedish Kronor Circulation Decline … Until Now?

On his blog, JP Koning argues that very short conversion periods rendered it unattractive for Swedes to hold cash. He also suggests that it were the banks that pushed for the short periods.

While digital payments share some of the blame for the obsolescence of paper kronor, the Riksbank is also responsible. The Riksbank betrayed the Swedish cash-using public this decade by embarking on an aggressive note switch.  Had it chosen a more customer friendly approach, Swedes would be holding a much larger stock of banknotes than they are now. As long as other countries don’t enact the same policies as Sweden, they needn’t worry about precipitous declines in cash demand.

Recently, the trend decline of kronor cash holdings has reverted. Across the board, the use case for cash seems to change (see also this post).

… even as developed countries are seeing fewer transactions completed using cash, the quantity of banknotes outstanding has jumped. This increase in cash outstanding, which generally exceeds GDP growth, is mostly due to an increase in demand for large-value denominations, as the chart below illustrates:

Cash Holdings Have Become Less Cyclical

On his blog, JP Koning reports that

[b]oth the Christmas bump and the sawtooth pattern arising from monthly payrolls are less noticeable than previous years. But these patterns remain more apparent for Canadian dollars than U.S. dollars. Not because Canadians like cash more than Americans. We don’t, and are probably further along the path towards digital payments then they are. Rather, the percentage of U.S. dollars held overseas is much larger than Canadian dollars, so domestic usage of U.S. cash for transactions purposes gets blurred by all its other uses.

Europe’s Response to the US-Iran Sanctions: Accounting Rather than Banking

On Spiegel online, Christoph Schult reports about “Instrument in Support of Trade Exchanges” (Instex), the new special purpose vehicle founded by France, Germany, and the UK with the task to facilitate legitimate trade with Iran. Instex is not meant to bust US sanctions, but to circumvent the banking sector which the the three countries perceive as “overcomplying.”

Eigentlich dürfen europäische Unternehmen alle Waren, die nicht den Sanktionen unterliegen, weiter in den Iran exportieren. Problem ist allerdings, dass fast alle Banken in Europa ablehnen, den Zahlungsverkehr für solche Geschäfte abzuwickeln. Die Geldinstitute haben Angst, sie könnten in den USA bestraft werden. “Overcompliance” von Sanktionen nennen das EU-Diplomaten – Übererfüllung.

Instex ist eine Art Tauschbörse, in der die Forderungen von iranischen und europäischen Unternehmen miteinander verrechnet werden. Geld, das Iran zum Beispiel für Öllieferungen nach Europa in Rechnung stellt, könnte direkt an europäische Firmen fließen, die Produkte nach Iran verkaufen.

Update (Feb 4): In the FT, Michael Peel discusses the SPV.

Obtaining a Fintech License in Switzerland

Guidelines published by the Swiss Financial Market Supervisory Authority. From the explanations:

The FinTech licence allows institutions to accept public deposits of up to CHF 100 million, provided that these are not invested and no interest is paid on them. A further requirement is that an institution with a FinTech licence must have its registered office and conduct its business activities in Switzerland.

SNB Grants Fintechs Access to SIC

In a press release the Swiss National Bank explains that it

grants access to … [fintechs] that make a significant contribution to the fulfilment
of the SNB’s statutory tasks, and whose admission does not pose any major risks. Entities with fintech licences whose business model makes them significant participants in the area of Swiss franc payment transactions will therefore be granted access to the SIC system and to sight deposit accounts.

The Swiss Financial Market Supervisory Authority is in charge of granting fintech licences.

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 …

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.