© Reuters. FILE PHOTO: The Federal Reserve building is seen in Washington, U.S., January 26, 2022. REUTERS/Joshua Roberts
By Howard Schneider
NEW YORK (Reuters) – Innovations in digital payments and the potential adoption of a central bank digital currency could force central banks to overhaul how they conduct monetary policy, potentially increasing their balance sheets and the tools used to control interest rates, Lorie Logan, executive vice president of the New York Federal Reserve, said on Thursday.
Logan, who heads the market operations for the New York Fed, was speaking generically about the impact of digital innovations on all central banks, not on the implications of a central bank digital currency for the Fed. The ultimate impact, she said, would depend on how a digital offering is designed, how broadly it is offered to banks, firms or households, and whether it pays interest.
But she and other speakers at a Columbia University and New York Fed symposium agreed that central banks’ potential journey into the world of cryptocurrencies and stablecoins could prompt dramatic changes in how monetary policy is conducted, and pose challenges in keeping control of interest rates and setting the size of the central banks’ balance sheets.
“The innovation occurring in money and payments has the potential to alter the existing…monetary system upon which current monetary policy implementation frameworks are
designed,” said Logan, who will be taking over as president of the Dallas Federal Reserve this summer. “How things evolve from here is uncertain, and the impact of these innovations could be revolutionary, or more evolutionary.”
Most global central banks are at least exploring whether to establish their own version of a digital currency.
If those end up drawing deposits away from legacy banks, for example, it could force central banks to increase their own balance sheets to provide more liquidity to the system.
“In some circumstances, the balance sheet could need to adjust rapidly because of unexpected large shifts in liability demand,” she said.
“In an environment with new public and private digital currencies, liquidity backstops for traditional banks may become even more important,” she said, referring to traditional short-term lending tools that central banks offer to commercial banks and other financial institutions.
Digital currencies “could enhance market efficiency,” she said, “but it may also lead to swings in deposit flows” that could effect the short-term interest rates central banks try to control.