Monetary policy in a world of cryptocurrencies


2019/04/30 15:00

Cryptocurrencies have attracted the attention of consumers, policymakers and the media. This column investigates whether they can jeopardise the primary function of central banks, namely, controlling inflation and economic activity. Currency competition can succeed in calming inflation and preventing the sort of manipulation of interest rates and prices to which governments have historically been prone. But currency competition may also lead to government money losing the function of medium of exchange, which could be risky and lead government currency into further troubles.


Can cryptocurrencies jeopardise the primary function of central banking – controlling inflation and economic activity – or at any rate limit their operational tools? The short answer is yes, they can.


Currency competition is not a recent phenomenon. Hayek wondered why government should be given the exclusive right to issue and regulate money, observing that it “…has certainly not helped to give us a better money than we would otherwise have had, and a very much worse one…” (Hayek 1976: 32). Things have changed since his time, and central banks in advanced economies have succeeded in controlling the value of their currencies and taming inflation.


Money is not an object, and indeed, it can be quite imaginary – cryptocurrencies are digital, not physically minted. It is even misleading, as Hayek observed, to think of ‘money’ as a noun: “…it would be more helpful for the explanation of monetary phenomena if ‘money’ were an adjective describing a property which different things could possess to varying degrees” (p. 56).1


To a certain or varying degree, cryptocurrencies have the same properties as traditional currencies, serving as medium of exchange, unit of account, and store of value. Chiefly, however, they function as a medium of exchange. Interestingly, monetary history offers other examples of uncoined money. As Luigi Einaudi (1936) noted, for centuries, ever since Charlemagne, an ‘imaginary’ money existed but served only as unit of account and never, unlike today’s cryptocurrencies, as medium of exchange.

加密货币在一定程度上或不同程度上具有与传统货币相同的属性,充当交易媒介、记账单位和价值储存手段。然而,它们主要起着交换媒介的作用。有趣的是,货币史提供了其他未创造货币的例子。正如路易吉•埃诺迪(Luigi Einaudi, 1936)所指出的那样,自查理曼大帝(Charlemagne)以来的几个世纪里,“假想”货币一直存在,但只是作为记账单位,从未像今天的加密货币那样作为交易媒介。

While digital and government currencies have some similar properties, government money also has special characteristics that today’s cryptocurrencies lack. Central banks also issue interest-bearing liabilities (reserves) and set policy in terms of this risk-free interest rate. Cryptocurrencies do not take the form of interest-bearing securities, and the growth in their supply is determined by an algorithm that allows new units to be minted. Government money is the liability of an agent, and the treasury can potentially back it by levying taxes. Digital currency is not the liability of any agent and has no fiscal backing.


Recent monetary theory has shown that if central banks set the rate of interest, and are supported by fiscal backing, inflation can be targeted without causing any volatility in the price level aside from that due to fundamentals (Sims 1994, Woodford 2001). In these cases, government currency has a definite value. Unbacked cryptocurrencies, by contrast, can become worthless if everyone comes to believe they are.

最近的货币理论表明,如果中央银行设定利率,并得到财政支持,通货膨胀就可以有针对性地进行,而不会引起价格水平的任何波动,除了基本面因素(Sims 1994, Woodford 2001)。在这些情况下,政府货币具有一定的价值。相反,如果所有人都相信无担保加密货币的价值,那么它们就会变得一文不值。

Despite the privilege that government money enjoys, it can enter dangerous territory in the presence of currency competition, as I discuss in a recent paper (Benigno 2019).2 To understand the challenges posed by digital currencies, consider the extreme case in which government and private money can both provide the same liquidity services. In such a world, the money that prevails as medium of exchange will be the ‘better’ one, i.e. the one with higher return and lower inflation. If the growth of cryptocurrencies is slow enough, and they keep appreciating in value, they could easily become the more convenient token for transactions. That is, government money could lose the function of medium of exchange while still, for the reasons set out above, retaining value. But the loss of some of the properties of money could be risky and lead government currency into further troubles. Agents could begin to ask why debt contracts should be denominated in this inferior currency, or even why they should have to pay taxes in it. Government could lose its privilege and its currency could go out of business.

正如我在最近的一篇论文(Benigno 2019)中所讨论的,尽管政府资金享有特权,但在货币竞争中,它也可能进入危险的领域。要理解数字货币所带来的挑战,考虑一下政府和私人资金都能提供相同流动性服务的极端情况。在这样一个世界里,作为交换媒介的货币将是“更好的”货币,即回报更高、通胀更低的货币。如果加密货币的增长足够慢,而且它们的价值还在不断升值,它们很容易就会成为交易中更方便的代币。也就是说,由于上述原因,政府资金可能失去交换媒介的功能,但仍然保留价值。但货币的一些属性的损失可能是有风险的,并导致政府货币陷入进一步的麻烦。代理人可能会开始问,为什么债务合同应该以这种较差的货币计价,甚至为什么他们应该用这种货币交税。政府可能会失去特权,其货币可能会破产。

If anything, currency competition should improve the quality of government money. To avoid being supplanted by digital currency, central banks would need to achieve a sufficiently low inflation rate, lower than that of private money. Where the forces of competition are even stronger (say, in the presence of a significant number of private currencies), it is the strictness of entry barriers that determines the bounds on inflation. And in extreme but not unrealistic cases, these bounds can be very low, requiring almost negligible inflation if not outright deflation.


Currency competition can succeed in calming inflation and preventing the sort of manipulation of interest rates and prices to which governments have historically been prone – a result hailed by the proponents of currency liberalism. The demand for liquidity can be satiated and frictions and premiums in the transaction markets minimised. In fact, Hayek argued against the monopoly on money supply: “It has the defects of all monopolies: one must use their product even if it is unsatisfactory, and, above all, it prevents the discovery of better methods of satisfying a need for which a monopolist has no incentive” (Hayek 1976: 28).


The recent financial crisis, however, has shown that the power of central bank money extends well beyond the property of medium of exchange. Central banks act as lenders of last resort to satisfy the liquidity needs of the economy, to make the financial system more resilient. What is more, the protracted situation of subdued inflation and zero interest rates has prompted the thesis that the inflation targets now being set by central banks are too low, and that a bit more inflation could be beneficial in avoiding liquidity traps as well as ‘greasing the wheels’ of the economy.


These social objectives can be internalised only by a central issuer, such as government, and surely not by a plethora of ownerless private currencies, even if they operate in ideal competitive markets. The advent of digital currencies just as national borders are fading away in favour of a worldwide web for transactions definitely represents a serious challenge to current central banking. It should therefore not come as a surprise to learn that central banks are studying how to issue digital currencies of their own.


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