Longer-term challenges
As policymakers struggle to meet the urgent near-term challenges, they should not
lose sight of a key longer-term one – regaining policy safety margins. As discussed
in detail in last year’s AER, over time the room for policy manoeuvre has narrowed
substantially. Government debt levels are at historical peaks, interest rates, both
nominal and real, have been falling to historical troughs and central bank balance
sheets have risen to levels previously seen only in wartime. The recent tightening of
monetary policy has,
so far, only marginally changed this picture, at least in AEs.
Economies operating without safety margins are exposed and vulnerable.
The current challenging environment does have one silver lining: it provides an
obvious opportunity for monetary policy to finally normalise. That said, it has also
highlighted a conundrum. Since regaining policy headroom is a joint task, the two
policies tend to work at cross purposes along the normalisation path. Now, monetary
policy tightening is materially raising the government’s financing costs at a time
when further demands on spending, both short- and longer-term, are growing.
Moreover, where central banks have engaged in large-scale asset purchases,
higher interest rates will also reduce central bank remittances to the government
(see last year’s AER). These central banks have de facto replaced long-term debt
with debt indexed to the overnight interest rate – the rate on bank reserves. As a
result, in the largest advanced economies, as much as 30–50% of marketable
government debt is effectively overnight. In the process, losses could heighten
political economy risks for central banks.
In part, this long-term joint normalisation challenge is itself the reflection of a
deeper problem. For far too long, there has been a temptation to turn to fiscal and
monetary policy to boost growth, regardless of the underlying causes of weakness.
For fiscal policy, in particular, loosening during contractions has not given way to
consolidation during expansions. The temptation to postpone adjustment has been
too strong. Such a strategy has arguably generated unrealistic expectations and
demands for further support.
As discussed in more detail in Chapter I, the only way of promoting robust
long-term growth is to implement ambitious structural reforms. Unfortunately, such
reforms have been flagging for too long. These reforms are more important than
ever at the current juncture, given the signs that globalisation may go into reverse,
partly due to geopolitical considerations.
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The future monetary system
Digital innovation will also surely play a key role in the long-term growth story, not
least through its impact on the shape of the future monetary system (Chapter III).
Policymakers face both urgent and important tasks. Some of these important tasks
do not always figure in the breathless commentary of market observers. A critical
one is to put in place the components of a future monetary system that serves the
public interest.
As a case in point on the twin dimensions of urgent and important policy
challenges,
this AER comes out at a time of turmoil in the crypto universe. The
recent implosions of the Terra stablecoin and its twin coin Luna are only the most
spectacular collapses in the crypto sector. As we write, many lesser-known coins
have seen their prices drop by more than 90% relative to their peaks last year.
Traditional financial stability concerns stemming from run risk are an urgent policy
challenge. However, focusing on prices diverts attention away from the deeper
structural flaws in crypto that make it unsuitable as the basis of a monetary system
that serves society. We should also keep these longer-term structural issues on our
radar.
For one, the prevalence of stablecoins in the crypto universe indicates a
pervasive need for crypto to piggyback on the credibility of central bank money.
Only the central bank can provide the nominal anchor that crypto craves. Crypto
started by turning its back on central bank money, but it has quickly rediscovered
the need for the unit of account function of central bank money. The same goes for
the medium of exchange function of money. Stablecoins are used to facilitate
transactions across more than 10,000 crypto coins, all competing for the attention
of speculative buyers.
The proliferation of coins also highlights the fragmentation of the crypto
universe, with many incompatible settlement layers jostling for a place in the
limelight. Gone is any pretence that money serves a coordination role. Money is the
pre-eminent example of network effects, which give rise to the virtuous circle of
greater use and greater acceptance. Rather than a single money gaining general
acceptance, thousands of different coins proliferate. Under the plausible-sounding
motto of “decentralisation and democratisation of finance”, crypto platforms have
mushroomed, all claiming to offer settlement of financial transactions. But the
congestion and high costs of these platforms have only opened the way for new
entrants, which cut corners on security in order to offer greater transaction capacity.
Money and its network effects should have the property of “the more, the
merrier”: the more money meets general acceptance, the more useful it becomes in
serving the public interest. Instead, the crypto universe heads in the opposite
direction: “the more, the sorrier”. The only participants who profit are the crypto
insiders, who extract rents from the speculative market on the back of new entrants
left holding the bag.
Having said all of this, the rise of crypto highlights the place of technology in
the popular imagination, and its galvanising role in debates on the shape of things
to come. In spite of its well documented flaws, crypto offers a tantalising glimpse of
potentially useful technical features that could enhance the capabilities of the
current monetary system. Notable examples include composability and automatic
execution,
which represent features with a potential to deliver instantaneous
settlement of transactions and transform the efficiency of economic arrangements.
The vision for the future monetary system set out in Chapter III is a fusion of
these enhanced technical capabilities with the core of trust provided by central
bank money. The traditional strengths of the two-tier system and the division of
labour between the central bank and the private sector can be translated into a
BIS Annual Economic Report 2022 xvii
setting with wholesale CBDCs, tokenised deposits and other tokenised securities or
assets. The classical notion of settlement via the book entries of intermediaries can
find new expression in DLT platforms on which tokens are transferred in settlement.
The economics remain the same, but the technological medium is transformed.
Retail fast payment systems with interoperability powered by application
programming interfaces, or APIs, bear a strong family resemblance to retail CBDCs.
The metaphor for the future monetary system is that of a tree. With a solid
trunk provided by the central bank, the tree hosts a rich and vibrant ecosystem of
private sector service providers serving users in order to meet their economic
needs. And this ecosystem is rooted, figuratively speaking,
in settlement on the
central bank’s balance sheet.
Central banks, as guardians of the monetary system, are embarked on a long
journey to fulfil the vision of making it versatile and robust. This journey is necessary
to put in place arrangements that anticipate future developments rather than
merely react to past developments. So, while the sound and fury of collapsing
crypto prices grabs all the attention, it is incumbent on us in the central bank
community to look ahead to these longer-term goals. For if we do not start today,
we will never get there.
