ifo Schnelldienst 16/2018, August 23, 2018. PDF.
- The Vollgeld initiative may point to a problem but it does not propose a viable solution.
- Even with Vollgeld, the time consistency friction with its Too-Big-To-Fail implication would persist.
- A more flexible, liberal approach appears more promising.
- It would give the general public a choice between holding deposits and reserves.
- Financial institutions and central banks around the world are pushing in that direction.
The Swiss National Bank held its annual general meeting of shareholders (web TV). In response to one of the questions posed by shareholders Thomas Jordan suggested (2:58–2:59) that possibly a digital Swiss Franc might be introduced sometime in the future.
In another excellent post on Moneyness, J P Koning likens the monetary system to the plot in the movie Inception, featuring
a dream piled on a dream piled on a dream piled on a dream.
Koning explains that
[l]ike Inception, our monetary system is a layer upon a layer upon a layer. Anyone who withdraws cash at an ATM is ‘kicking’ back into the underlying central bank layer from the banking layer; depositing cash is like sedating oneself back into the overlying banking layer.
Monetary history a story of how these layers have evolved over time. The original bottom layer was comprised of gold and silver coins. On top this base, banks erected the banknote layer; bits of paper which could be redeemed with gold coin. The next layer to develop was the deposit layer; non-tangible book entries that could be transferred by order from one person to another.
The foundation layer has changed over time:
One of the defining themes of modern monetary history has been the death of the original foundation layer; precious metals. … as central banks chased private banks from the banknote layer … and then gradually severed the banknote layer from the gold layer. By 1971, … [b]anknotes issued by the central bank had become the foundation layer. The trend towards a cashless world is a repeat of this script, except instead of the gold layer being slowly removed it is the banknote layer.
Fintech improves the efficiency of the layer arrangement and its connections. It also adds new layers: For instance, some payments made via mobile phone effectively transfer claims on deposits. And it may circumvent layers:
In U.K., the Bank of England is considering allowing fintech companies to bypass the banking layer by offering them direct access to the bottom-most central banking layer.
In contrast, a krypto currency like bitcoin establishes a new foundation layer, on which new layers may be built:
Even now there is talk of a new layer being developed on top of the original bitcoin foundation, the Lightning network. The idea here is that the majority of payments will occur in the Lightning layer with final settlement occurring some time later in the slower Bitcoin layer.
I fully agree with this characterization. In addition to the theme emphasized by Koning—adding layers—I would also stress the theme of untying higher-level layers from lower ones: Central bank money typically is no longer backed by gold; deposits typically are not fully backed by notes; and mobile phone credits may no longer be backed by deposits. The process of untying layers relies on social conventions and trust, and it is fragile. Important questions concern the cost of such fragility, and its necessity. Fragility is not necessary when the social cost of liquidity provision at the foundation layer is negligible.
- Vollgeld seems attractive because it decouples the supply of money from intermediation. By enabling everyone to use legal tender for electronic payments, electronic base money would satisfy a need.
- Vollgeld would prevent bank runs, at least partly; render deposit insurance unnecessary and reduce moral hazard; could help stabilize the credit cycle; and would redistribute seignorage to the central bank.
- But these objectives can be obtained with less intrusive means.
- Moreover, a Vollgeld system would be hard to enforce. Banks and their clients would establish new means of payment to circumvent the regulation. And in times of crisis, the central bank would feel obliged to provide liquidity assistance and bail outs.
- The central problem is not that private money is used for transactions; it rather is that the money’s users rely on the central bank to guarantee the substitutability of private money and base money. In a democracy, the central bank cannot credibly let large parts of the payment system go under.
- A sudden, forceful change of regime does not offer a credible way out of this trap.
- But letting the general public access central bank reserves without abolishing private money from one day to the other may open a path towards a new arrangement where the public learns to distinguish between private and base money and where only the latter is publicly guaranteed.
- Allowing the general public to hold reserves at the central bank could help reduce the risk of bank runs and the negative consequences of deposit insurance.
- It would end the need to accept bank deposits as means of payment although they are not legal tender; this need arises due to prohibitions on cash payments, for tax reasons.
- But it could also have negative consequences: Money and credit creation by banks would be undermined, with social costs and benefits.
- Price stability and financial stability could be threatened during the transition period.
- More technical questions would have to be addressed as well: They concern the payment system or the conduct of monetary policy.
- Proposals to go further and to abolish cash are not convincing. One suggested benefit—more leeway for monetary policy makers—is over estimated: Negative rates can also be engineered (effectively) through fiscal policy, and they can fully be implemented with a flexible exchange rate between reserves and cash.
- Another suggested benefit—better monitoring of tax dodgers and criminals—is also overrated; the fixed cost to circumvent the measure would deter minor illegal activity but not major one.
- But abolishing cash would have severe negative consequences for privacy and could negatively affect financial literacy.
- Enforcing an abolishment of cash would be difficult. In a free society, any reform to the monetary system is constrained by the requirement that money must remain attractive for its users.