Could central banks issue digital currency to manage monetary policy?

Digital Pound UK Currency Money 450With central banks playing an integral role in restoring stability since the financial crisis, leading to dramatic changes in central bank balance sheets, researchers and strategists at the Bank of England have questioned how they may continue to evolve.

An electronic form of central bank money that could be used by the general public is one possibility, James Barker and David Bholat from the Bank of England’s advanced analytics, research and statistics division and Ryland Thomas from the monetary assessment and strategy division suggest in their Bank Underground blog.

“Currently, reserves are the only electronic form of central bank money that exists, with banknotes being the physical form, and only a select number of financial institutions have access to them,” the trio say. “Digital currency could potentially provide the central bank with another tool through which to conduct monetary policy, as both the quantity and/or the interest rate of the digital currency could be adjusted.”

However the caveat is that if the issuance of banknotes does not fall to match the rise in digital currency, it would increase the bank’s liabilities, which would require it to buy more assets – such as government bonds.

“Central banks may not want to hold more for fear of distorting bond markets, political worries about monetary financing, or simply because there are not enough government bonds in circulation. Although there has been a lot of discussion about how central bank digital currency could radically change payment systems – and even the financial sector as a whole – the implication for the assets on central bank balance sheets could be just as critical,” the BofE staff say.

Other possibilities include central banks making greater use of their equity to implement policy, as in theory they could achieve the same effect as quantitative easing by issuing central bank shares in exchange for private sector assets, or a “helicopter money drop” – essentially creating further liabilities without receiving assets in return.

“[Central bank] shares would be different from conventional shares in a listed company as they wouldn’t give voting rights on the activities of the central bank, but apart from that, they would be similar. An upside of using equity to buy private sector assets is that the central bank would be strengthening its capital base at a time when it’s taking on more risk.”

Helicopter money could be implemented by the Bank of England issuing a perpetual zero-coupon government bond, Barker, Bholat and Thomas say, although this would prompt “important questions about central bank independence”.

“Unlike bonds purchased in QE, this couldn’t ever be sold and would therefore provide a commitment never to unwind the policy, leading arguably to a larger impact on the economy. However, economists at the department for business, innovation and skills have argued that helicopter drops would do more harm than good.”