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Electronic Money versus Paper Currency: The Case of Central Banks’ Monetary Policies

If electronic money is issued through the conversion of banknotes or sight deposits, it does not change the money supply and price stability is not endangered. However, if electronic money is issued as a consequence of credit, private issuers have incentives to supply additional amounts of electronic money as long as the difference between the interest charged on the credit and the one paid on electronic money covers the credit risk premium, the provision of the payment service, and possibly also the cost of refinancing. Given the low marginal cost of producing electronic money, its issuance could in principle proceed until the interest rate charged on the credit extended for the provision of electronic money is equal to the credit risk premium. This, by lowering the level of interest rates, could in turn endanger the maintenance of price stability.
The risk of overissue would be limited by two factors which increase the costs of issuing electronic money, thereby limiting its supply: first, in a competitive environment, electronic money balances could be remunerated; second, and more importantly, a redeemability requirement could oblige the issuer to possess central bank money. An even stronger measure, which could be considered in the light of future developments in electronic money, would be to introduce a coverage requirement on electronic money, i.e. to request issuers of electronic money to cover part or all of their liabilities with base money. Another way to limit the risk of overissue would be to require rapid clearing of electronic money balances in central bank money.
Thus, it appears that there are several reasons to assume that the risk of overissue of electronic money can be contained. However the issuance of electronic money may have an impact on the conduct of monetary policy.
The question of overissue of electronic money is also related to the question of whether electronic money could endanger the unit-of-account role as incorporated in central bank money. If, in the absence of any regulation, certain electronic money products were to spread at a rapid rate, market views about the creditworthiness of issuers could be affected and electronic money products from different issuers could start to be traded at varying exchange rates. Therefore, the need to preserve the unit-of-account function of money is another argument for imposing a redeemability requirement on electronic money. Such a requirement would guarantee that the role of money in providing a common financial denominator for the whole economy will be maintained.
But, what are the challenges as far as central banks monetary policies are concerned? The danger from the high degree of substitute of currency in circulation with e-money is presented through the influence of decreasing central bank balance sheet, which means limitation of their positive influence on the monetary instruments. In order to avoid this negative influence in the near future, there is another possibility taken into consideration and that is the possibility for the central bank to impose reserve requirements on all issuers of electronic money.
The impact of the emergence of electronic money on monetary policy can mostly be expected in the following areas:
a)  Decrease in the control of central bank over money supply. Decreasing the central bank’s control of money supply depends on the degree of substitution of currency in circulation with e-money. The currency in circulation is part of monetary aggregates, and if it is decreased as a result of wider use of e-money, it will produce difficulties in measurement of monetary aggregates and of the control of money supply by the central bank. Possible solutions for limitations of this effect are for example, limitations of the use of e-money. But this will be in direct confrontation with the laws of technological progress and could produce negative external effects on the banking in general. Because of that, there is a need for intensified research on new opportunities to limit the adverse impacts of replacing cash with electronic money.
b)  Increase in the velocity of money. The influence of e-money over monetary policy can be seen through monetary aggregates, the ability of the central bank to control money supply. In the future impact should be seen through indicators related to monetary aggregates, like the velocity of money. With the use of e-money, transactions are relatively cheaper which allows increase in the number of transactions, and increase in the speed of money. Generally speaking, it will be useful, but only to the level that the central bank could control or measure the monetary aggregates.
c) Volatility in exchange rates. The change of the monetary multiplier is an important indicator. This indicator shows the share of currency in the money supply. As a result of e-money the currency decreases producing effects to multiplier.
d)  With the use of currency, the need for printing cash is decreasing, which influences the revenues of central banks.
e)  E-money has a characteristic of easy portability and affordability which offers a wide use in trade among countries. It is assumed that the user of e-money, motivated with the cheaper foreign currency transactions, will prefer the transactions to be in the most powerful currency. So, through PayPal and other services, users from the country with weaker currency will prefer to transfer their money in higher currency. So in this way the dollarization or euroisation will be a subject to clicking the mouse. But still, this situation can weaken the central bank’s control in the process of foreign currency exchange among the countries.
Still, all these analyses and facts about the influence of e-money on the monetary policy of the central bank will be part of future scenarios. Today, with the current use of e-money there is no room to worry on the part of central banks. Still, there is no broad willingness to accept e-money because of the expensive implementation, insuf ciently developed supervision, need for broader statistics and also the danger from hackers. In the future, we could expect decrease of the currency, but it will be without larger effects or without reasons for any dramatic changes in the monetary policy.
Originally posted here


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