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The Future of Money in the Information Age

Chapter 16: The Effects of E-Money on Monetary Policy: Comments on Selgin, Ely, and Jordan/Stevens

William A. Niskanen

It is remarkable that three thoughtful analyses of the effects of e-money on monetary policy come to three very different conclusions.

Selgin's Analysis

Let me first address the paper by George Selgin, because this paper makes the simplest point. Selgin concludes that the substitution of e-money for currency will increase the effectiveness of monetary policy by reducing the variance in the money multiplier due to changes in the public demand for currency. The import of Selgin's conclusion, I suggest, is dependent on two assumptions: (1) the availability of e-money will substantially reduce the demand for currency, and (2) monetary policy is best conducted by controlling some monetary aggregate for which the central bank can be held responsible.

I doubt whether Selgin's first assumption, that e-money will crowd out much currency, is a probable outcome, but I must acknowledge that I do not understand the current demand for currency. Even if only one-third of U.S. currency is in circulation in this country, that amount is about $500 per person or $1,000 per member of the labor force. I have no idea who holds all this currency and where. I doubt whether the average amount held in one's wallet is more than $50. If e-money replaces all wallet currency that would only reduce the demand for currency by up to 10 percent. If that is the only effect, there would be no substantial change in the level and variance of the money multiplier.

On the issue of how best to conduct monetary policy, I suggest that the jury is still out. Given the variance of both the income velocity of money and the money multiplier, the central bank may do better to directly target some economic aggregate, such as nominal GDP or the price level, and make whatever adjustments in their monetary instruments are necessary to stay on the target path. My own contribution to this debate is to recommend that the most appropriate target path is the nominal level of domestic final sales. In some sense, this debate involves a tradeoff between economic importance and institutional accountability. On this issue, I suggest, it is better to roughly control some important economic aggregate than to precisely control some monetary aggregate--better to be roughly right than precisely wrong. For a central bank that uses such a recursive, error-correcting monetary policy, a reduction of the variance of the money multiplier is not very important.

Ely's Analysis

The paper by Bert Ely, in contrast, concludes that the substitution of e-money for currency will have no effect on monetary policy. Ely offers two quite different arguments for this conclusion.

First, he focuses a jeweler's eye on the commercial prospects for e-money. He suggests that the market for stored-value cards may be no larger than about $10 billion and questions whether the gross income of about $600 million would be sufficient to cover the costs of providing and marketing these cards. In this case, there would be no significant effect on the demand for currency. On this issue, I suspect that Ely is probably right, although his estimate of the potential market for stored-value cards may be off by a factor of 2 in either direction.

Second, he uses his paper to summarize his broader challenge to the conventional perspective on monetary policy. He asserts that the Federal Reserve does not control the money supply because it cannot; both currency and bank reserves, he contends, are demand determined with the federal government passively supplying whatever the market demands. Moreover, he asserts that the Federal Reserve's only effect on interest rates is a consequence of a broad but false perception that they can actually change rates.

On this issue, I am reminded of my mother's comment when I marched in the high school band that ``Everyone is out of step but my Billy.'' On this issue, in other words, I suggest that Ely is wrong. Bert and I have talked about this issue several times, but he has yet to persuade me by the internal logic of his analysis or to pose a testable statement that could be checked against the evidence. I am especially skeptical of his assertion that everyone other than Bert Ely is fooled about the ability of the Federal Reserve to change interest rates. But I invite you to make your own judgment on this issue.

Jordan and Stevens's Analysis

For balance, Jerry Jordan and Edward Stevens play the role of the typical two-handed economist. On the one hand, they argue, several trends are apparent and will continue:

Technology and market developments will continue to reduce the demand for currency and bank reserves, possibly to zero.
These same developments will reduce the ability of governments to regulate the money industry.

On the other hand, they argue, the magnitudes of these effects are uncertain and, maybe, cannot be anticipated with any confidence.

On both of these issues, I suggest, Jordan and Stevens are well informed, thoughtful, probably correct, and not very helpful. The issue is not our inability to forecast the effects of technological and institutional innovation. I had hoped, however, for some advice on how the various affected institutions may best respond to the current and sequentially developing information about the effects of these innovations. We may be on the eve of a revolution on the nature of money and banking, but what should individuals, business managers, private bankers, government regulators, and central bankers do about this, if anything, when they go to work tomorrow morning?

Conclusion

My view is that the three papers provide little guidance about the effects of e-money on monetary policy, other than to suggest that the possible effects may range from trivial to revolutionary. In my judgment, the specific effects of e-money will be small; I do not expect stored-value cards to substitute for much currency, banks have a strong incentive to reduce their reserves whatever the developments in technology, and the effects of many changes is just to reduce float. For this observer, the regulatory implications of e-money seen more interesting and more important.

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