The e-Money Revolution: Challenges and Implications for Monetary Policy

Economies everywhere are in the midst of an e-commerce revolution. This revolution is ushering in new methods of transacting and payment, and in doing so it promises to introduce new monies (e-monies) that may ultimately come to displace existing money - both currency and bank deposits. In assessing the possible future impact of e-money, it is useful to distinguish between two types. The first is e-tail money, and the second is e-settlement money. e-tail money stands to replace currency and demand deposits for traditional transaction purposes. e-settlement money stands to replace use of demand deposits for purposes of discharge of private debts, and it also stands to replace use of central bank reserves for purposes of settlement of clearing balances amongst banks.

The e-money revolution fits naturally into the history of money as told by Austrian economists.The Austrian approach emphasizes the endogeneity of the “form” of money which changes in response to technical innovations and market competition. However, not only does the e-money revolution promise to change the form of money, it also stands to change the workings of the banking system, and in doing so may undermine the monetary authority’s ability to set interest rates and stabilize financial markets

The e-money revolution also has implications for Post Keynesian monetary theory which emphasizes the central bank’s control over the short-term costs of funds. In the simplest of accounts (Rousseas, 1985), commercial banks set their loan rate as a mark-up over the central bank determined short-term cost of funds. Given this horizontal loan supply schedule, the quantity of bank lending is then set by the demand for bank loans, which in turn determines the quantity of bank deposits. In effect, causation is reversed relative to the conventional money multiplier story, so that loans create deposits rather than deposits creating loans. More complicated Post Keynesian models (Palley, 1987) allow for bi-directional causality. Rather than being a fixed mark-up over the cost of short-term funds, commercial bank loan rates are influenced by the composition of bank assets and liabilities. This in turn means that interest rates and the quantity of lending are influenced by wealth holders’ willingness to hold bank liabilities and banks’ willingness to hold different types of loans

In both cases the central bank plays a critical role by setting the short term cost of funds (in the U.S. this is the federal funds rate), and in doing so it exerts a powerful influence over interest rates. e-money poses a challenge to this Post Keynesian description of the credit money creation process by challenging the central bank’s ability to control interest rates (Friedman, 1999). The foundation of this challenge is the possibility that e-money may eliminate the financial system’s demand for liabilities of the central bank so that the central bank is unable to control the supply price of liquidity through meaningful open market operations

Most importantly, the spread of e-settlement money stands to potentially destabilize the financial system. This is because agents will retain the option of demanding central bank money in settlement, which means that there will always be the risk that agents will switch and demand payment in such form. If this happens it will create a massive destabilizing liquidity shortage. This “instability” risk poses a significant problem, and policy makers should be directing their attention toward it

Economies everywhere are in the midst of an e-commerce revolution. This revolution is ushering in new methods of transacting and payment, and in doing so it promises to introduce new monies (e-monies) that may ultimately come to displace existing money - both currency and bank deposits. In assessing the possible future impact of e-money, it is useful to distinguish between two types. The first is e-tail money, and the second is e-settlement money. e-tail money stands to replace currency and demand deposits for traditional transaction purposes. e-settlement money stands to replace use of demand deposits for purposes of discharge of private debts, and it also stands to replace use of central bank reserves for purposes of settlement of clearing balances amongst banks