Speaking in Kyiv at the National Bank of Ukraine, the Governor of the Bank of England (BoE) spoke about the role of central banks in the context of changing market structures and events 1. His speech throws an interesting light on recent developments in the US and Europe in this area.
The Governor started by making the point that central banks are independent from governments under terms set out in legislation. However, they are not independent of the people, central bank independence is granted by their representatives in parliaments.
These banks are, though, responsible and accountable for their objectives. The legitimacy and authority of banks depend on this accountability. There are typically two objectives of modern central banking – monetary and financial stability. The ability to manage shocks is the real test of policy frameworks in respect of monetary and financial stability. It is one thing to develop frameworks in relatively calmer times, but to persist they must be able to stand up and deliver in the face of big adverse shocks.
The task is both to respond to the shock itself when it hits, and then to the consequences of the shock, which can be quite different. This is where appropriate flexibility and strong transparency and accountability are critical.
Currently, central banks combine floating exchange rates and free cross-border capital movements with independent monetary policy oriented towards the domestic objective of price stability. Central to achieving this objective is a so-called nominal anchor, usually an inflation target which seeks to stabilise the real value of money.
Ukraine’s experience allows central banks to start to assess whether this approach is robust in the sense that it can handle severe economic shocks. This is the critical test. The Governor concluded that – whilst always accepting that the job is never done – it has passed the test.
As mentioned above, the Governor spoke about the two key central bank objectives – monetary and financial stability. Monetary policy being the real value of money, price stability, and low and stable inflation. It is about confidence in the future of money, the value of money in real terms. Financial stability is about ensuring the future nominal value of money.
A key part of this is confidence in the singleness of money, that the unit of money in one bank account is the same as the one in another bank account at another bank, and that they will be equal to and freely exchangeable with a unit of central bank money, such as a banknote.
The Governor argued that monetary policy and financial stability cannot be achieved satisfactorily without each being achieved. This task is becoming more complex because of the way money is developing. Not all of the financial system comprises money and the share of the non-money system in the total has grown of late. In addition, there can be evolution in the precise form that money takes.
Today, over half of the financial system is not money in the sense that it is held outside the banking system. The BoE has adopted the term ‘non-bank financial institutions’ (NBFIs) to describe these institutions, which is largely the world of investment where the nominal value of your investment is not assured.
But is there sufficient clarity about whether the NBFIs are maintaining sufficient capital and liquidity to provide assurance of the nominal value? What about risks which can originate outside the banking system but then spread into it? Banks and non-banks are not insulated from each other. Have central banks over-protected the banking system via excessive regulation, and in so doing pushed more risk into non-banks which would be more safely housed in banks?
Cryptocurrency, or digital money, takes two distinct forms: unbacked assets of the Bitcoin sort, and backed assets of the stablecoin sort.
Looking to digital currency, while money has been in a digital form for many years, the question is how do we get the benefits of new digital technologies in the area of payments – where money is a medium of exchange?
Eg. the benefits of smart contracts in payments, and the benefits of using digital technology to fight fraud.
The Governor made the comment, ‘I remain to be convinced that we need to create new forms of money – such as Central Bank Retail Digital Currency – to achieve this’, ie. these benefits.
Central banks are well on the way to having wholesale central bank digital money which is unsurprising given that this is just a natural step on from the wholesale electronic money that the BoE has had for 30 years.
If there are real benefits to digital technology in payments, then these need to be seen in commercial bank money.
Tokenised deposits, the application of digital technology to the commercial bank money we currently use, is the route to this – preferably used in both domestic and crossborder currency payments. Commercial banks need to step up to the challenge of digital money provision.
The Governor said, ‘I am not against stablecoins, but they do have to meet the test of singleness of money. I am not against Central Bank Retail Digital Currency, but I question why it is needed if innovation proceeds as I think it should.’
1 - Central Banking in extreme adversity - speech by Andrew Bailey | Bank of England
