By Michael S. Derby and Marc Jones
NEW YORK (Reuters) -Central banks should still be able to conduct monetary policy effectively and perhaps be even nimbler in a more decentralized financial system, according to the findings of a joint report released on Wednesday by the New York Federal Reserve and the Bank for International Settlements.
The report said a prototype system designed to conduct monetary policy in a financial system reliant on new, more automated systems “successfully responded and instantaneously carried out the intended operation under the varying market conditions, consistent with the central bank’s desired liquidity environment.”
The prototype created for the study showed there’s even the possibility of central bank monetary policy working even better under a decentralized financial system. The project came out of work done by the New York Fed’s Innovation Center and the Bank for International Settlements’ Innovation Hub, as part of the Project Pine effort.
“Central banks could use smart contracts to easily and quickly create new facilities or adjust existing ones to optimize the implementation of monetary policy in a tokenized environment,” which means future operations could be “nimbler in uncertain conditions and potentially reduce frictions between the time of announcements and offerings,” the report said.
Tokenization refers to assets with digital tokens on a blockchain.
The report noted that the research was conducted in conjunction with inputs from a number of central banks and its setup was generically oriented rather than tailored to the operations and goals of a particular central bank. The project was undertaken as part of preparatory efforts to make sure central banks will be ready for any future changes in financial markets.
The prototype system covered by the report is designed to perform most of the key technical functions that monetary policy does now to achieve central bank policy goals.
While there is no current threat to how central banks now intervene in markets to set interest rates and manage market liquidity, rising decentralizations and new technologies, some of which are in use already, could change that at some point.
“If the private financial sector adopts tokenization on a broad scale in wholesale markets, central banks may need to participate in novel financial market infrastructures and interact with digital tokens to continue effectively implementing monetary policy,” the report said.
Decentralized financial systems could also create “emerging challenges” for money created by the central bank, the report said. In terms of central bank operational issues “the additional complexity of central bank operations has increased incentives to use technology to automate tasks and processes.” At the same time, “central banks still face a challenge in integrating automated processes with those that require human judgment.”
(Reporting by Michael S. Derby; Editing by Paul Simao)
