The Role of the Central Bank in Payment Systems

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The Role of the Central Bank in Payment Systems

• Edward J. Green
• May 2005

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Aims of the talk

• Suggests how economics should influence central
  bankers thinking
• Examine some specific theories
• Implications
• Limitations
• Propose criteria to assess theories
• Internal consistency
• Qualitatively accurate implications

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Payment system

• A comprehensive system
• Not a component
• Examples
• Large-value systems
• Payment-card systems
• Resembles a market
• Numerous entities contribute
• Comparative advantage

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Central bank role (preview)

• Manage a system of settlement accounts
• Provide short-term credit
• Accept illiquid collateral

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Two questions regardingcentral bank role

• Must a monetary authority be involved with
  payment systems, in order to be effective?
• Does a central bank have comparative advantage in
  performing some beneficial payment functions?

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Must a monetary authority be involved with
payment systems?

• Yes, if controlling the supply of clearing
  balances is essential to monetary policy (King)
• No, if the interest rate can be pegged without
  issuing money in equilibrium (Woodford)
• Suggestions that involvement has incidental
  benefits are unconvincing

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If yes, then must CB money be the only settlement
asset?

• Advantages of inside money suggest not
  (Cavalcanti-Wallace)
• CB monopoly possibly avoids sunspots (Smith)
• Clearinghouses competently and responsibly
  provide settlement assets
• Both historically and currently

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Market structure -- operators

• Supply
• Economies of scope and scale
• Payment systems seem to be contestable
• Demand
• Network externalities
• Myopic, noncooperative behavior would imply
  inefficiency
• Contracts or repeated interaction can achieve
  efficiency

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Market structure -- participants

• Settlement at end of day can be an inefficient
  market outcome if
• Early settlement is costly
• Early settlement is a public good
• Payment system participants behave
  noncooperatively
• End-of-day settlement actually occurs
• It is not necessarily inefficient

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Intrinsic comparative advantage of central
banks

• Maintaining a system of settlement accounts
• Transferring balances among those accounts
• Offering free, short-term credit to facilitate
  settlement
• Accepting illiquid collateral

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When a central bank role is justified

• The CB has an intrinsic comparative advantage
• An economy of scope with a role justified by
  intrinsic comparative advantage creates
  comparative advantage in another activity
• Such situations are difficult to verify
• The advantage from CB involvement is probably
  small
• Overall, the case for such involvement is weak

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Where the central bank may have a comparative
disadvantage

• Providing technology
• Value-added services
• Regulation?
• The CB can propose and promote desirable rules,
  without being the regulator
• The CB has limited expertise in some aspects of
  regulation
• Risk of apparent or actual conflict of interest

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Conclusion

• A central bank contributes immensely to payment
  systems by
• Maintaining a system of accounts for a money with
  stable value
• Offering free, short-term credit on illiquid
  collateral
• The potential benefit from further involvement
  seems to be marginal, at best