“The term [electronic] money refers to various proposed electronic payment mechanisms designed for use by consumers to make retail payments. Digital money products have the potential to replace central bank currency” (Berentsen 1). This quote indicates that the advent of electronic money will have an impact on the banking system and monetary policy. While this topic is controversial it seems obvious that some changes will result and that there is no prefect answer to predict this new instruments affect on monetary aggregates and the role of central banks. Its growth will be based on many things: future technology, increased security, regulation, and ease of conversion. It can impact such variables as monetary supply, exchange rates, the money multiplier, velocity of money and seignorage. Increased reliance on electronic money as a substitute for currency will directly affect the central bank and its control over monetary aggregates and policies.
Electronic money is the money balance recorded electronically on a “stored-value” card (Ely 1). These cards, “smart cards,” have a microprocessor embedded which can be loaded with a monetary value. Another form of electronic money is network money, “software that allows the transfer of value on computer networks, particularly the internet. Like a travelers check, a digital money balance is a floating claim on a private bank or other financial institution that is not linked to any particular account” (Berentsen 1-2). This money is issued by both public and private institutions worldwide and is raising concern about the future ability of central banks to set money supply targets. It is widely used in such places as “Germany, the Netherlands, Belgium, Singapore, and Hong Kong” (Tak 48).
The increased use of electronic money has lead to various studies about the impact this new form of money could have on central banks’ ability to control the money supply. Many economists believe electronic money could completely replace currency while others feel that its impact will be less drastic. The ability to control the money supply depends on the definition of money, M1. M1 currently includes currency, traveler’s checks and demand deposits. If the use of these variables were to decrease due to an increased reliance on electronic money, M1 would not serve as an accurate measure of money in the economy. The decreased ability to measure monetary aggregates will limit the central bank’s ability to conduct open market operations and target the money supply. This will be offset by the fact that “new digital monies are fully backed by assets such as gold or high-quality financial instruments. Therefore, the need to conduct open market operations will diminish, because the supply of money for transactions should automatically adjust to demand” (Rahn 4). If the money supply is assumed to be fixed, “when the currency weight decreases gradually as the use of electronic money increases, the scale of the central bank’s assets and liabilities will be reduced, which may lead to a weakening of money management and of the interest rate management through open market operations” (Tak 77).
The idea that digital money is commodity based may be overly optimistic. The possibility of fraud could lead the central bank to want to limit the changes to M1 and prevent the growth of electronic money. The following measures could be taken:
• Limit the proliferation of digital money products to prevent the replacement of central bank currency
• Issue digital money products and treat digital money balances in the same way as they do central bank currency
• Apply high reserve requirements on digital money balances
• Absorb the excess liquidity created by appropriate monetary operations (Berentsen 9).
These would allow the central bank to maintain control of monetary aggregates though it may do more harm then good by limited technological improvements. Resistance to change may not be the best approach though any acceptance should come with hesitation as a drastic immediate change could cause turmoil in the economy.
The velocity of money is also affected by the increased use of electronic money. An increase in the velocity of money is considered by Rahn to be gradual and requires a compensating adjustment in base money by the Federal Reserve. He feels that the Fed should be able to adjust accordingly as the changes will be “gradual and obvious” (Rahn 4). Tak feels that it “will be difficult to measure the resulting changes in velocity because income circulation velocity is calculated from the ratio of a term-end money supply and national income from that period. It is difficult for the circulation velocity resulting from this calculation to reflect effective money flows from electronic settlement properly. Electronic money will inevitably reduce the time and space disposal of expenses of payment settlement transactions, and increases the volume of transactions by promoting transaction convenience” (Tak 55). It can be seen that the velocity of money will increase if electronic money is first adopted as a major form of money and second added to the aggregates used to compute the velocity of money. Transactions will take place in real time across thousands of miles and transaction costs are greatly reduced causing people to increase the number of transactions made. While increased velocity is a good thing the inability to measure it when electronic money is not included in monetary aggregates decreases the central banks ability to control monetary policy.
Electronic money is expected to completely change the character of cross country trade and exchange rates. Due to the ease of transfer of these funds, electronic money denominated in a stronger currency could be preferred and therefore would cause “exchange rate instability, not only giving rise to instability in the financial system but also working as a factor limiting the influence of monetary policy” (Tak 62). This would lead to an increased need for central banks to acknowledge foreign currencies and policies in order to maintain control of its domestic monetary aggregates. Electronic money breaks down the barriers between countries and could one day lead to a universal currency backed by a commodity based basket of goods and services with universal price set in an auction market (Rahn 5). Decreased ability to control cross country currency exchanges lowers the central bank’s control of the money supply.
The money multiplier is directly affected by the increased use of electronic money as a replacement for conventional currency. “When electronic money is introduced, currency decreases and deposit money increases as the private propensity to retain cash goes down. Therefore, the currency ratio is reduced, the money multiplier becomes larger, and the volume of money supply created from the supply of fixed reserve money is amplified” (Tak 57). This shows that electronic money will directly affect the money multiplier through the currency ratio.
Electronic money as well affects reserves. If reserve requirements are placed on electronic money balances, there is no change because it is assumed that currency will decrease by the same amount that electronic balances increase. However, this assumes that reserve requirements can be set on all electronic money balances. This is not the case when private institutions are liable for the smart cards and network money. If the central bank takes corrective action, it can limit the inflationary affects of increased money. Rahn feels that this will not be a problem as the changes will be slow and measurable, therefore allowing central banks to adjust appropriately (Rahn 4). If this assumption is overly optimistic about the central banks abilities it can be seen that the central bank could in fact lose control and inflation could result from increased use of privately issued electronic money.
Lastly, and probably the most agreed upon affect of electronic money is the loss of “seignorage” income, “the interest savings the government earns by issuing non-interest bearing debt in the form of currency” (Ely 2-3). This money is used to run the central bank and therefore the loss of it could cause central banks to suffer financially. This money is also used to fund the budget deficit and other government programs and the loss of this could hurt the government. This loss could be combated by treating electronic money balances similar to demand deposits and enforcing reserve requirements.
The increased use of electronic money will:
• Limit the central bank’s ability to control money supply
• Increase the velocity of money
• Lower seignorage income
• Decrease reserves
• Decrease international monetary control
• Change the money multiplier
All of these effects are contingent, however, on the actual increased use of electronic money. Many experts feel that it will not replace currency due to its lack of security and the cost of implementing it.
The first of these concerns, lack of security, arises from the idea that fraud is increasingly possible with this technology. Anyone could manipulate technology to create a card or electronic balance that was not actually commodity backed. While currency is also fraudulently created, it is much more difficult to do based on the complexity of the currency system in most countries. A lack of security arises from the fear that network money balances can be controlled, stolen or manipulated by online hackers. Lastly, people may be unlikely to store large balances in electronic money for fear that a simple lost wallet could result in a loss of hundreds of dollars. Like currency, it is easily transferable and therefore could be considered unsafe for storing large sums of money (Ely 2).
The cost of implementing widely used electronic money systems may limit their expansion as well. In order to expand the system, retailers and service organizations would have to pay to install systems that would allow them to accept this form of payment. Many may not be willing to do this when the current payment system seems sufficient. Unless it is made mandatory it seems unlikely companies would pay the money to implement a system that just adds to the current transaction times and costs (Ely 2).
The future of electronic money is dependent on its growth, the regulation of it, and increased technological advancements that would increase the security of this new instrument. If in fact it does become widely used in the United States it will directly impact the central bank’s control of monetary policy unless the central bank includes it in its measurements of monetary aggregates and regulates its growth and usage.
Tak, Seung-Ho. “A Study on the Effects of the Development of Electronic Money on Monetary Policy in Korea.” Economic Papers, Bank of Korea. 5.1 (July 2002):47- 79.
Ely, Bert. “Electronic Money and Monetary Policy: Separating Fact from Fiction.” The Future of Money in the Information Age, CATO Institute’s 14th Annual Monetary Conference. 23 May 1996. CATO Institute, 25 Nov. 2002 http://www.cato.org/moneyconf/14mc-2.html
Seign, George. “E-money: Friend or Foe of Monetarism.” The Future of Money in the Information Age, CATO Institute’s 14th Annual Monetary Conference. 23 May 1996. CATO Institute, 25 Nov. 2002
Rahn, Dr. Richard W. “On the Future of Electronic Payments.” CATO Congressional Testimony. 19 Sep. 2000. CATO Institute, 25 Nov. 2002
Berentsen, Aleksander. “Digital Money, Liquidity, and Monetary Policy.” 1997. First Money, 25 Nov. 2002