Digital Currencies and Monetary Policy Challenges
In recent years, cryptocurrencies have proliferated and gained immense popularity in western countries and financial markets. Nevertheless, cryptocurrencies, such as Bitcoin, are still not a liquid form of payment that is widely accepted for everyday transactions as some expect will be the case in the future. Currently, major questions remain surrounding what economic and financial effects the widespread acceptance of cryptocurrencies would have in developed market economies. Like most countries, the United States only has one official and widely accepted currency, the US Dollar, which is regulated by the federal government. Since 1971, the US Dollar has been a free floating currency, backed only by the good faith of the federal government and not by any metallic mineral, such as gold.
Digital Currencies and Monetary Policy Challenges
The widespread use and acceptance of parallel cryptocurrencies within the western economies would require the proliferation of an international payment system that accepts these currencies. Similarly, it would require the simplification of cryptocurrency wallets for individuals to carry around Bitcoin or other electronic currencies and have them readily available. If or when this scenario becomes a reality, official government agencies, particularly the Federal Reserve, would have an even harder time than it already does in regulating national monetary policy.
In the distant and unlikely case that cryptocurrencies became an everyday payment method for households and retail, there would be two or more parallel currencies circulating within the US economy. Likewise, the Federal Reserve would only be able to implement monetary policy on one of them and the aggregate Money Supply within the economy (counting both currencies) would increase. For example, in the case of interest rates, which are set by the Federal Reserve through the commercial banking system, cryptocurrencies would not be directly affected by official interest rates. Nonetheless, it can be expected that, as the interest rates on the US Dollar rise, individual savers would migrate from cryptocurrencies towards the Dollar and individual borrowers would migrate towards whichever currency is less costly to hold debt on. Simultaneously, the issue of an increased aggregate Money Supply through cryptocurrencies can be problematic because it would represent an uncontrolled degree of quantitative easing (QE) or helicopter money that would have to be counterbalanced by the central financial authority. Fortunately, thus far, most cryptocurrencies have limited and paced the release (or mining) of new value units.
Another important economic indicator within this hypothetical framework would be inflation. If cryptocurrencies proliferate to a large degree, at least in major financial centers, the prices of items would be presented in dollars as well as in a cryptocurrency amount. Thus, in the short-term, the overall inflation of the national economy would be somewhere between that of each currency or pricing system. Based on current trends, the Dollar would continue to register a positive inflation of approximately 2.0%, whereas cryptocurrencies would continue to gain in value and popularity, thus registering a floating level of deflation or appreciation. However, it is be expected that both the Dollar and cryptocurrencies would, in the long-term, register similar levels of either inflation or deflation.