Research Discussion Papers, Bank of Finland
No 26/2001:
Payment and financial innovation, reserve demand and implementation of monetary policy
Harri Lahdenperä ()
Abstract: The consequences of electronic trading, payment and
settlement have recently become one of the main topics in monetary
economics. New innovations in payment and settlement technology are
challenging the central bank’s monopoly over the supply of base money,
which is generally considered the cornerstone of the central bank’s power
to set the short-term interest rate for the economy. This paper
demonstrates that the development of the economy’s transaction technology
over time has indeed had a significant quantitative impact on the demand
for currency and bank reserves, and indirectly on the modalities of the
supply of reserves by the central bank. In contrast to past trends, the
latest innovations in payment and settlement technology imply not only a
quantitative change but also a qualitative one, as they enable private
institutions to issue settlement money that competes with the liabilities
of the central bank. The paper presents a model on the implementation of
monetary policy in an economy where such private substitutes for central
bank money are available for the settlement of transactions, showing that
effective monetary control by the central bank might indeed be compromised
in those circumstances. However, the study also highlights several
attributes that may distinguish central bank liabilities from any private
alternatives, some of which are based on the central bank’s traditional
role as the banker for the Government.
Keywords: monetary policy; reserve demand; payment systems; financial innovation; (follow links to similar papers)
JEL-Codes: E41; E43; E51; (follow links to similar papers)
61 pages, December 12, 2001
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