Blockchain technology and smart contracts have made certainty in monetary policy a legitimate possibility, argue Max Raskin and David Yermac

Raskin, Max

Yermack, David

LSE Research Online

11/22/2016Central banks of developing nations should issue digitalcurrencyblogs.lse.ac.uk /businessreview/2016/11/22/central-banks-of-developing-nations-should-issue-digital-currency/Bitcoin keychain extended background, by BTC Keychain, under a CC-BY-2.0 licenceOver the past few months, academics and central bankers have been involved in a dialogue over whether centralbanks issue digital currency. We have made our own contribution to this conversation, but perhaps we should beasking a different question. In addition to whether central banks should issue digital currency, we should ask  whichcentral banks should.Thus far, the central banks of England, Canada, and Ireland have all addressed the question, and South Koreajoined the discussion with an announcement earlier this week. While there may certainly be benefits to thesedeveloped nations from adopting digital currency, many are rightfully concerned about the dramatic increase in statepower and the temptation for chicanery that would follow from a national, centralised banking institution with accessto citizens’ bank accounts. Transparency here could become a vice given the background norm of the rule of lawthat undergirds these societies.Contrast this with developing nations whose commitment to the rule of the law is on shakier grounds. Here, thetransparent nature of open blockchains could offer a number of advantages. They could encourage foreigninvestment and ameliorate the uncertainty that comes with investing in countries that have histories of monetarymismanagement and nationalisation. Investors may have more confidence in code that they can examinethemselves than in the temporary assurances of individual leaders.Loose monetary policy represents an endemic problem for many countries. The temptation of the printing press isgreat, and without a firm commitment to central bank independence, the money supply could be subject to thevicissitudes of political or personal caprice. For governments anxious to re-launch their monetary policy in a credibleway, a digital currency incorporating self-executing “smart contracts” could make practical a rules-based monetarypolicy.1/2In countries where monetary discretion is sometimes abused, an algorithmic monetary policy could be valuable,much like a country deciding to peg its currency to the U.S. dollar. There is a great deal of academic literature onwhether rules-based or discretionary approaches to monetary policy are preferable. Countries like Argentina andZimbabwe have less of an ability to effect counter-cyclical monetary policy on a global level, and so limiting theirdiscretion has less of a cost than it would in more developed economies.There would be no need for these smart contracts to tie one nation’s currency to another’s. Instead, a country couldadopt something like Milton Friedman’s k-percent rule, which calls for a central bank to increase the money supply acertain percent regardless of the phase in the business cycle. The Taylor Rule is another alternative. Whatever thealternative, however, certainty in monetary policy is the hallmark of an advanced nation, and the emergence ofblockchain technology combined with the use of smart contracts has made this a legitimate possibility.Another advantage for countries with unstable commitments to the rule of law of adopting blockchain technology isthat bank accounts would be less likely to be tampered with. The reason why grey markets exist for currency incountries like Iran and Argentina is that the citizens have more faith in exogenous staples than in their ownleadership. Similarly, placing faith in the cryptography that underlies a blockchain and not in the good faith of theirgovernments may be wise for citizens of certain countries. Governments looking to attract foreign investment wouldbe able to show a certain degree of public transparency to combat misperceptions if they are, in fact, incorrect.Nigeria and its oil corruption scandals, for instance, could benefit from bank accounts and ledgers where there is acertain degree of transparent accountability that a blockchain offers.♣♣♣This blog post is based on the authors’ paper Digital Currencies, Decentralized Ledgers, and the Future ofCentral Banking, NBER Working Paper No. 22238, May 2016The post gives the views of the authors, not the position of LSE Business Review or the London School ofEconomics.Before commenting, please read our Comment Policy.Max Raskin is a fellow at the New York University School of Law.   David Yermack is the Albert Fingerhut Professor of Finance and Business Transformation andChairman of the Finance Department at New York University’s Stern School of Business, where hehas been a member of the faculty since 1994. Copyright © 2015 London School of Economics2/2

Central banks of developing nations should issue digital currency

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