Monetary Policy, Monetary Areas, and Financial Development with Electronic Money
Keywords: electronic money, monetary policy, monetary unions.
The recent evolution of the technology for financial transactions poses interesting questions for policymakers and financial institutions regarding the suitability of the current institutional arrangements and the availability of instruments to guarantee financial stability, efficiency, and effectiveness of monetary policy. The aim of this paper is to dispel some of the most extreme predictions.
The disappearance of money, central banks made redundant, monetary policy made irrelevant are not logical impossibilities, but extreme events. It is not impossible to envision a world with these most extreme characteristics (King, 1999) and to describe its functioning in the new setup, but how likely are these events to occur? The view that they will happen in the foreseeable future cannot be shared. From an operational point of view, we need to ask whether the actual institutional arrangements can respond properly to the recent wave of financial infrastructure innovations and if their policy instruments are still viable.
Regulatory concerns are raised by internet banking, electronic finance (e-finance), and e-money but are not addressed in these notes. Here the focus is primarily on the forces sustaining the development of e-money and on the central bank ability to conduct monetary policy in the presence of e-money.2
This paper argues that e-money, as a network good, could become an important form of currency in the future. Such a development would influence the effectiveness and implementation of monetary policy. If an increased use of e-money substantially limits demand for central bank reserves, it would require changes in the operational target of the central bank and a closer coordination of monetary and fiscal policies. The optimal size of monetary unions could differ should e-money play a prominent role.
However, the current level of e-money use does not pose a threat to the stability of the financial system, and central banks have the means to successfully implement the objectives of monetary policy.
With respect to the current debate on the consequences of the introduction of e-money on the implementation of monetary policy and in contrast with earlier work on this topic (Freedman, 2000; Friedman, 2000; Goodhart, 2000; and Woodford 2000), this paper argues that central banks can lose control over monetary policy if the government does not run a responsible fiscal policy. Central banks could react to this threat by introducing additional regulation or by resizing the monetary areas which they ought to regulate, as we shall argue in later sections.