The Fed’s long-awaited report on central bank digital currencies is finally out. Although the report makes it clear that the Fed has no immediate plans to issue a digital currency, it does point to the approach the Fed would be inclined to take were it to do so.

That approach would have the Fed supply a retail digital currency to the general public indirectly, using private-sector financial intermediaries, including but not limited to commercial banks, as its agents. Those private intermediaries would then be responsible for managing customers’ central bank digital currency (CBDC) holdings and payments.

Intermediated versus “Synthetic” Central Bank Digital Currency

Superficially, the Fed’s preferred approach seems identical to the “synthetic” central bank digital currency (sCBDC) approach first recommended by Tobias Adrian back in 2019. In that approach, both bank and nonbank private-sector payment service providers can have accounts with their central banks and hold those central banks’ digital liabilities. Retail digital currency (“eMoney”) is supplied exclusively by these private-sector payment service providers, but is fully backed by central bank reserves that are ring-fenced from those providers’ other creditors. The result, Adrian says, is one in which the public may be said to hold and transact in central bank money “by proxy.”

Adrian refers to his sCBDC plan as “a public-private partnership.” It remains the case, nonetheless, that the central bank itself only supplies “wholesale” digital currency. Another article summarizing the sCBDC plan makes this especially clear. In a sCBDC arrangement, it says,

the central bank is not offering accounts to the general public but instead to private EMIs, who then use the sCBDC as a 100% backup for their e‑money. This is an important difference between CBDC and sCBDC. … Similar to current e‑money, [sCBDC] constitutes a claim against one specific e‑money institute.[1]

The alternative proposed in the Fed’s report is also a public-private digital currency arrangement, which it calls “intermediated” central bank digital currency. For parallelism’s sake, let’s call it iCBDC.[2] Under the iCBDC plan, banks and nonbank payment service providers “would offer accounts or digital wallets to facilitate the management of CBDC holdings and payments.” However, “the CBDC itself would be a liability of the Federal Reserve.” In other words, instead of being suppliers of their own retail digital currencies, the Fed’s private-sector partners would be acting as its agents, that is, as custodians and trustees of their clients’ holdings of its digital currency, much as several U.S. banks now hold private cryptocurrencies, including U.S. dollar stablecoins, in custody for their customers. Rather than being part of commercial banks’ on-balance-sheet assets or liabilities, CBDC held in custody would presumably be an off-balance-sheet item. Instead of transacting in CBDC money “by proxy,” users of iCBDC would transact using retail CBDC itself.

Franchisees versus Competing Suppliers

The sCBDC and iCBDC proposals seem so similar that one may wonder whether the difference between them is even worth noticing. Are they not equivalent in practice? The answer is that, while they may be equivalent in certain respects, in others they aren’t. And where they aren’t, the difference matters in a way that favors “synthetic” over “intermediated” CBDC.

The most important respect in which the two plans are alike is that both would see to it that the public’s digital currency holdings are perfectly liquid and entirely free of courterparty risk. The iCBDC would accomplish this by allowing the general public to have access to digital central bank liabilities, whereas the sCBDC would do it by granting private retail digital currency providers, including nonbanks as well as banks, access to “wholesale” CBDC, that is, to central bank settlement balances, to hold as backing for their own retail digital currencies. Even 100-percent reserve-backed sCBDC would not be quite as safe as iCBDC, however, because default by a private sCBDC issuer, though unlikely, would still be possible, with that likelihood depending on the size of the issuer’s capital buffer.

Where the two plans would differ most in practice is in the extent to which each would promote digital currency diversity and ongoing innovation. As Adrian notes in making the case for sCBDC, that arrangement

encourages competition between eMoney [that is, retail digital currency] providers and preserves comparative advantages. The private sector concentrates on innovation, interface design, and client management. And the public sector remains focused on underpinning trust.

Whereas the sCBDC plan allows for numerous, entirely distinct retail digital currencies, the Fed’s iCBDC plan provides for a single digital currency only, albeit one offered at and administered by numerous private-sector firms. The difference is like that between a monopoly franchising arrangement and a competitive one, where the Fed is the franchisor and various private-sector payment service firms are its franchisees. Like any franchising monopolist, the Fed can be expected to exercise ultimate control over the features of its product, with the aim of keeping it reasonably uniform. It might also seek to make its digital currency particularly more convenient for certain purposes, such as global payments, than for others. And it might favor having it programmed so as to serve certain special purposes, while not allowing it to be programmed in other ways. The Fed’s intermediaries would, presumably, have to comply with these and other Fed preferences. Consequently, an iCBDC is likely to be a fairly, if not fully, homogeneous digital product, instead of a set of such products with different features designed to serve the needs of different clients. The same arrangements that tend to limit product diversity in a franchisor-franchisee arrangement may also discourage ongoing innovation.

For these reasons, as true as it may be that the Fed’s preferred plan “could provide a safe foundation for private-sector innovations to meet current and future needs and demands for payment services,” I’m pretty certain that the sCBDC alternative would supply a better one. At very least, the Fed should favor policies that would encourage the development of various sCBDC’s alongside its own iCBDC, especially by having it grant Master Accounts to both “special purpose” banks and nonbank fintechs, instead of treating iCBDC as an alternative to this approach. It is, however, far from obvious that an iCBDC would serve any purpose sCBDC’s could not serve more efficiently provided that their development is encouraged.

Now, or Never?

Another advantage of the sCBDC option is that the Fed can begin implementing it now. To do so, it only has to start granting Master Account balances to private digital currency issuers. Current law allows it to grant such accounts to any chartered depository institution, whether it has an ordinary bank charters or a “special purpose” charter. The Fed can also insist that private DC issuers maintain 100 percent Master Account backing for their digital currencies as a condition for allowing them to have such accounts. I’ve argued the case for its doing so elsewhere. (For more details see my May 24, 2021 comment letter on Fed procedures for granting Master Accounts.)

Because it isn’t legal as yet for the Federal Reserve to grant Master Accounts to nonbank payment service providers, its ability to promote sCBDC growth is correspondingly limited. I believe that the Federal Reserve Act should ultimately be amended to allow nonbank digital currency suppliers to take part in a sCBDC arrangement.

But while the present Federal Reserve Act (FRA) may limit participation in a sCBDC plan, it may rule the Fed’s own iCBDC plan out altogether. Section 13 of the FRA grants the Fed the power to receive deposits “from any of its member banks, or other depository institutions, and from the United States,” but not from private individuals. Section 16 of the Act allows the twelve Federal reserve banks to issue paper Federal Reserve notes. But no part of the FRA expressly allows the Fed to supply any sort of digital payments media directly to the general public. Furthermore, should Congressman Tom Emmer (R‑MN) have his way, the Act would be amended to expressly prevent the Fed from doing so.

Although the Federal Reserve’s CBDC report makes clear that it would not consider issuing any sort of digital currency “without clear support from the executive branch and from Congress,” the report also suggests that the Fed’s proposed “intermediated” CBDC would not be prohibited by the present Federal Reserve Act, because while that Act “does not authorize direct Federal Reserve accounts for individuals,” under its proposed plan “the private sector would offer accounts or digital wallets to facilitate the management of CBDC holdings and payments.” I am no lawyer, but it seems to me very doubtful that the mere management of what is acknowledged to be a Fed CBDC, owned not by banks but by their customers, with the banks serving only as iCBDC custodians, would suffice to make iCBDC legal. At very least, its legality would rest on a very slim reed, consisting of the pettifogging distinction between the Fed’s providing “accounts” to individuals and its providing its digital liabilities to them, as if by ruling out individual Fed accounts the FRA didn’t intend to keep the Fed from allowing individuals to hold its digital liabilities.

For these reasons, I very much hope the Fed will abandon its proposed “intermediated” CBDC solution in favor of a “synthetic” CBDC alternative; and I hope others will join me in urging it to do so.

________________

[1] Why certain people, including many economists, insist on writing “similar to,” when they mean “like,” is beyond me. But I deeply suspect that these persons are the very same ones who say ‘like” constantly, for no reason at all, when speaking.

[2] Both of these terms are, admittedly, unfortunate. It would be better if what others call “synthetic” CBDC were itself called “intermediated” CBDC, for it’s in this arrangement that private payment service suppliers may truly be said to invest funds borrowed from their customers in central bank digital liabilities. On the other hand„ what the Fed calls “intermediated” CBDC would be better described as “custodian-managed” CBDC. It’s unfortunate that in banking a “custodial” account is one managed by an adult or adults on behalf of a child. Otherwise “custodial” CBDC would serve.

“There Was No Housing Bubble in 2008 and There Isn’t One Now,” concludes Ramesh Ponnuru. Writing in Bloomberg, Ponnuru notes that, ” economists David Beckworth and Scott Sumner have argued that the timing of the last housing bust does not line up with the conventional wisdom that it played a central role in the recession that began in December 2007. The housing market peaked in early 2006, and sustained nearly two years of decline before the economy stopped growing as unemployment stayed low.”

“A monetarist explanation for the Great Recession,” he adds, “is that the Federal Reserve erred from late 2007 onward by failing to loosen monetary policy enough after initial signs of economic weakness, sending tightening signals to markets as the crisis developed, and then failing again to do what it would take to revive spending levels.”

There are couple of vital sub-plots I would like to add to this incisive investigation of economic policy history. First, the price of WTI crude oil soared from $50 a barrel in January 2007 to $89 by the start of the Great Recession, then continued rising to $145 by the middle of 2008, in mid-July. As in 2021, the rapid runup in crude oil prices in 2008 was associated with a simultaneous rise in CPI inflation when measured on a year-to-year basis. Second, as Ponnuru notes, both years were widely considered to be “housing bubbles” which supposedly deserved to be popped by the Fed.

The biggest difference between now and 2008 has to do with “quantitative easing” (QE) ­– that is, buying Treasury debt with bank reserves that have paid interest since October 2008. Today, the Fed plans to phase-out the latest of four dubious QE experiments. And the Fed also plans to raise the interest rate it pays on bank reserves, which is far more relevant than the fed funds rate in an era when the banks have been flooded with reserves by QE.

The graph shows that in 2008, the Fed went much further and engaged in aggressive Quantitative Tightening (QT). Federal Reserve Bank holdings of Treasury debt were deliberately reduced from $790.5 billion in the second quarter of 2007 to $478.2 billion in the second quarter of 2008. It is hard to imagine why Fed officials thought that was a clever idea unless they saw QT as a way to crash the world price of oil by crashing the world economy.

The fed funds rate was high at 4% in January 2008 and was still 1.8% in September 2008, ten months into a deep contraction. But that was mild poison compared to the astonishing Quantitative Tightening of 2008.

After nearly a year, the Federal Reserve has finally released its discussion paper on central bank digital currencies (CBDCs). For a 40-page document, the findings were actually rather thin. It seems the Fed is still undecided, but it is leaning towards launching a CBDC that would protect privacy without permitting anonymous use, be intermediated (or hosted) by private banks, and be easily transferable. In other words, it would be much like what already exists.

To justify the launch of the new system, the Fed lists improvements to the payments system, financial inclusion, and the dollar’s international status as potential benefits of a CBDC. Yet a CBDC is hardly necessary to fulfill these ends considering these are already areas that are being actively improved.

The U.S. payments system––one that does resemble that of a developing nation––is long overdue for an upgrade, but that is not to say that upgrades are not underway. The Clearing House launched such an upgrade back in 2017. In fact, by all signs, the system they launched would have been nearly in full effect by now had the Fed not interrupted its progress with the announcement of a competing service––a service that is not expected for another year. However, if the Fed is set on being at the helm, there is even a third option available. The Fed could simply expand its operating hours to fix much of the issue today. It may not be clear which option will go into full effect first, but the system will likely be fixed long before a CBDC hits the market. So really, a CBDC is hardly a benefit here.

Financial inclusion is a worthy goal as well, but one that similarly falls flat. The discussion paper devotes just two paragraphs to the “possible benefit of financial inclusion,” and it ultimately concludes with a request for research that would confirm the possibility. However, research already shows that the number of unbanked individuals has been declining every year. So, again, it’s possible that this is one problem that will be fixed before a CBDC is launched. Second, 75% of the unbanked say that they are simply uninterested in having a bank account. And third, two of the key reasons for being unbanked are concerns about privacy and trust. Considering the public’s trust in the government is at historic lows, it’s unlikely a CBDC will be winning any hearts. Thus, it is again unclear how much of a benefit a CBDC will be here.

The final benefit described is the idea that a CBDC would support the dollar’s role as the world’s reserve currency, and this benefit probably holds the most weight of the three. However, it’s not without issues. First, any improvement to the utility of the dollar will support its international status––a CBDC is not a unique solution here. Second, it’s not clear that adopting a digital currency is enough for other nations to unseat the dollar’s status as the world’s reserve currency. While it may be an improvement for some foreign currencies to “go digital,” those currencies still have other problems that will keep mass adoption at bay. China’s digital currency is a good example. Although China is ahead of the United States in the “digital currency race,” it is unlikely that the world will flock to its digital currency because of the considerable lack of privacy one is subjected to in the Chinese digital currency system. So while a CBDC may in fact be beneficial for the United States in this respect, so too are any number of other ways that might improve the dollar.

Maybe it shouldn’t be such a surprise that the discussion paper was finally released considering CBDC legislation is also underway. However, it’s still unclear what the Fed has been doing since May 2021. What started as a “summer publication” soon became “expected in the fall” and then “in the coming weeks.” Now that it is finally here, it seems that the Fed and Congress have a long road ahead if they wish to justify such a program to the public. The first place they should start is in identifying how a CBDC can be anything more than a solution in search of a problem.

The Cato Institute’s mission is to originate, disseminate, and advance solutions based on the principles of individual liberty, limited government, free markets, and peace. Within the Center for Monetary and Financial Alternatives, we narrow that scope to the realm of monetary and financial policy. And while our work often involves digging into the weeds to assess the merits of specific pieces of legislation, it’s always important to step back and ask what the subject of our work means for liberty. Today, that subject is cryptocurrencies.

So, what do cryptocurrencies mean for liberty?

Free Choice

At the most fundamental level, the mere existence of cryptocurrencies creates opportunities for people to make choices that were unheard of just over a decade ago. But more specifically, cryptocurrencies offer the potential for choices to be made in a realm long dominated by government monopolies––the realm of money.

It’s not unusual for people to seek alternative currencies in times of hyperinflation or unstable regimes. In fact, the U.S. dollar is a popular choice (hence the term “dollarization”) in desperate times, but getting the physical dollars to other countries can have its challenges. Normally the U.S. government is happy to ship those dollars across land or sea, but that service can stop at a moment’s notice when global politics get in the way. For example, the U.S. government stopped all shipments of U.S. dollars headed to Afghanistan––a heavily dollarized economy––shortly after the Taliban took control of Kabul in August 2021. At no fault of their own, the citizens of Afghanistan were suddenly without access to dollars and forced to find an alternative as a cash shortage set in.

Where cryptocurrencies have the potential to become a widely accepted money, they also have the potential to provide a choice that is free from both poorly managed governments and global politics. That alone is a major step forward for liberty across the world.

Financial Privacy

However, cryptocurrencies offer more than just an alternative to escape national currencies, poorly managed or otherwise. They can also offer a layer of protection for one’s financial privacy that is missing from most national currencies.

To understand why financial privacy is in need of greater protection, consider the case of China where the government recently increased financial surveillance through the launch of a central bank digital currency (CBDC). Or, consider the case of India where plans are underway to launch a CBDC because it can be designed to “promote non-anonymity at the individual level” and “monitor transactions.” Partly because cryptocurrencies offer such an attractive alternative to CBDCs in regard to privacy, both the Chinese and Indian governments are also actively trying to ban cryptocurrencies.

While the U.S. government’s plan for a CBDC is still uncertain and it has not resorted to banning cryptocurrencies (at least, not directly), Americans are still right to be concerned about their financial privacy. A 45-year-old ruling by the Supreme Court has held that people cannot reasonably expect privacy when providing information to a bank, or third party. Most recently, the dismal state of financial privacy and the weight of this so-called “third party doctrine” was put on full display when a proposal to monitor bank accounts with at least $600 in annual transactions was announced. That proposal may be off the table for now, but the message was clear: a person’s privacy protections only go so far with the U.S. dollar and traditional banking system.

For some people, cryptocurrencies may be exactly what is needed to better protect their privacy. Despite the fact that cryptocurrencies are not completely anonymous, users are still offered a heightened level of financial privacy because decentralized cryptocurrencies (e.g., Bitcoin) remove the banks from the equation. Therefore, there is no third party to pressure for information if the bitcoins in question are held in a self-hosted wallet.

If a government wishes to access the information in such a wallet, it must go through the traditional legal system to secure a warrant. That idea, of course, is precisely what underlies the Fourth Amendment to the U.S. Constitution and should be the norm. So, while the U.S. courts may be following the law when they choose to side with the third-party doctrine, the protections for one’s privacy offered by cryptocurrencies is clearly more in tune with the spirit of liberty that the United States was built upon.

Censorship Resistance

The protection of one’s financial privacy is important, if for no other reason, because financial privacy is often violated by governments seeking to censor individuals. Across the world, governments freeze the financial accounts of activists and rivals in attempts to eliminate their competition. However, regardless of if an account is frozen in the midst of a toppled regime or in an advanced economy, one thing remains the same: governments turn to private banks to have the accounts frozen. And those banks have to comply.

The absence of a third-party intermediary (e.g., a bank) in decentralized cryptocurrencies, of course, means that there is no one for the government to pressure to release a person’s information except for the direct owner of that information. In the United States, where financial privacy has been weakened by the third-party doctrine, the absent third party means that the government cannot circumvent the traditional legal system to stop or censor a person’s financial activity. In effect, by strengthening the protection that the Fourth Amendment provides, decentralized cryptocurrencies can better protect Americans from government censorship. And while one would be correct to note that cryptocurrency miners are involved in the process, the miners receive no information in addition to what appears publicly on the blockchains and no one miner has control of the system.

The lack of any one controlling party is a key component of the system’s ability to resist censorship. If the government stopped a miner from updating the ledger, there are countless other miners across the world that would continue to ensure the ledger is kept up to date. In fact, this resiliency was put on clear display when China cracked down on cryptocurrencies in 2021. As illustrated in Figure 1, despite China eliminating 44% of the world’s Bitcoin mining power (measured by the hash rate), the decentralized system was fully restored in just a few months.

Property Rights

Cryptocurrencies, and the blockchains they are built on, also have a role to play in preserving property rights. Not only do the qualities described above preserve individual ownership, but cryptocurrencies can also play a direct role in enforcing contracts.

Enforcing contracts is one of the few roles a limited government should take on. However, despite it being a fundamental role of government, not all governments enforce contracts effectively. Contracts hold little value where governments are compromised by corruption. Worse yet, even where the rule of law is upheld, contract enforcement can be prohibitively expensive. Through smart contracts built with cryptocurrencies, however, the role of enforcement no longer rests with the government alone.

As noted by Brian Armstrong, “Smart contracts move enforcement from the courts to the blockchain.” In short, a smart contract is a digital contract where the underlying code requires conditions to be fulfilled before the contract can be executed and automatically enforced. Unfortunately, smart contracts have many challenges to overcome if they are to gain widespread use. However, even with those challenges in mind, it is already clear that they have a beneficial role to serve in preserving property rights in developing and advanced nations, alike.

Borderless

Finally, cryptocurrencies can improve exchanges across national borders because transactions on blockchains do not discriminate between an address in New York City and an address in Paris. And the transactions are often more transparent than those in the traditional banking system.

Unfortunately, governments have largely restricted banks in their ability to service cross-border payments. It can take as long as five business days on average for transactions to settle. Part of that delay is due to the banks checking (and rechecking) for the possibility of fraud or money laundering, as required by most governments. In late 2021, 55 percent of the banks surveyed by the Financial Action Task Force said complying with multiple regulatory requirements significantly slowed their settlement times. Worse yet, 66 percent of those banks said multiple regulatory requirements also raised the cost of cross-border payments. (The global average for remittance payments in 2021 was 6.38% for $200, or $12.56.)

However, cryptocurrencies are inherently borderless and transparent. Because there is no distinction between sending cryptocurrencies to someone next door versus someone across the world, the transaction will likely be near instantaneous compared to the traditional system––an especially important feature when sending money home in times of crisis and an especially important feature for the free movement of one’s wealth. However, the details of those transactions will also be forever preserved on the blockchain, enhancing the ability of governments and citizens alike to find those who engage in criminal behavior.

Conclusion

So, what do cryptocurrencies mean for liberty?

Cryptocurrencies offer a new range of choices and opportunities that never before existed. They offer protections for financial privacy that should be already offered by the Fourth Amendment. They offer censorship resistance that protects individuals from authoritarian and overbearing governments, alike. They enhance the ability of individuals to enter reliable contracts. They improve the movement of wealth across the world. And overall, cryptocurrencies offer the opportunity for individuals to gain financial independence from the government.

No two cryptocurrencies are created equal. However, in principle, cryptocurrencies offer the potential to enhance liberty across the world. And for that, they are something worth fighting for.

On December 5, 1996, Alan Greenspan, then chairman of the Federal Reserve, gave one of his most memorable speeches, “The Challenge of Central Banking in a Democratic Society.” In that speech, given while accepting the Francis Boyer Award from the American Enterprise Institute (AEI), he coined the term “irrational exuberance.” Greenspan asked, “How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions … ? And how do we factor that assessment into monetary policy?”

Monetary Policy and Financial Stability

That question remains to be answered as the Fed ponders tapering its large-scale asset purchases (also known as quantitative easing or QE) and raising its policy rate. The Fed has no crystal ball to tell it when there are asset bubbles or whether those bubbles need to be tamed by more restrictive monetary policy. Nevertheless, Greenspan realized that monetary policy cannot be separated from financial stability:

We should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.… A central mission of the Federal Reserve [is] to maintain financial stability and reduce and contain systemic risks. This mission is an extension of our monetary policy. Our country cannot enjoy the long-run “maximum employment and stable prices” objectives we are given for monetary policy if the financial system is unstable.

While recognizing the importance of financial stability, Greenspan was reluctant to outguess markets if they looked frothy. What he did do is to have the Fed seek to set a floor beneath stock prices, which become known as the “Greenspan put.” Thereafter, market participants expected the Fed to support asset prices by lowering the policy rate whenever markets tanked, but not try to prick a bubble. That policy has continued ever since.

Although “irrational exuberance” has gained the most attention from Greenspan’s speech 25 years ago, there are other parts of his speech worth reflecting upon—namely, the social function of money, the Fed’s primary mission, the limits of monetary policy, central bank independence, and rules versus discretion in the conduct of monetary policy.

Money’s Social Function

Greenspan began his speech by reminding us that “at root, money—serving as a store of value and medium of exchange—is the lubricant that enables a society to organize itself to achieve economic progress.” Sound money (i.e., money that maintains its long-run purchasing power), is the glue that holds a free-market system together. In contrast “erratic money” (i.e., wide variations in the quantity of money relative to the demand for money), distorts market price signals and the allocation of resources. Rational economic calculations, especially those affecting investment decisions, become more difficult when the future value of money is uncertain. Inflation and deflation that follow from erratic money undermine both economic and social order. As Greenspan notes,

the general price level, that is, the average exchange rate for money against all goods and services, and how it changes over time, plays a profoundly important role in any society, because it influences the nature and scope of our economic and social relationships over time.

It does so not only by influencing the allocation of resources but by impacting the distribution of income. Prices do not move uniformly following an excess supply of money or in response to monetary deflation. There will be winners and losers. Consequently, monetary policy will always have political implications depending on the interest groups affected. In the current environment of near-zero interest rates and QE, investors in stocks and real estate have gained, while those holding saving accounts with negative real interest rates have lost.

Greenspan recognized the distributional effects of erratic money and stated: “Any institution that can affect the purchasing power of the currency is perceived as potentially affecting the level and distribution of wealth among the participants of that society, hardly an inconsequential issue.”

The Fed’s Core Mission

For Greenspan, the Fed’s “most important mission … is monetary policy.” The key facet of that policy is to maintain long-run price stability. That is why he told his AEI audience that the Fed must act as the “ultimate guardian of the purchasing power of money,” and must be held accountable. Today’s calls for expanding the Fed’s mandate to include climate change and racial/​economic equity (see, e.g., “The Federal Reserve Racial and Economic Equity Act”), among other responsibilities, would take the central bank far beyond what Greenspan saw as its core mission.

The Limits of Monetary Policy

Greenspan clearly recognized that monetary policy is a blunt tool for achieving long-run economic growth, which depends on increasing real factors—such as labor, capital, and technology—as well safeguarding private property and the rule of law. Activist monetary policy may spur economic growth in the short run, but cannot do so in the long run. If it could, then all that need be done to increase the wealth of nations would be to drop money from helicopters. (See Dowd on helicopter money.)

Even though the Phillips curve has lost its shine, the rhetoric of a permanent tradeoff between inflation and unemployment is still heard, especially from so-called progressives and “modern monetary theorists.” Even the Fed acts as if it can use monetary policy to push employment to its optimum rate—that is, to attain the so-called natural rate of unemployment. Not much is said about the negative impact of high taxes, government bloat, minimum wages, unions, regulations, and certain welfare programs on labor markets and employment. Some politicians seem to think the Fed has a magic wand to create jobs and real economic growth.

Greenspan was under no such illusion. He criticized the view that excessive money growth alone could permanently expand output and employment. But he understood that there were still those who held the view that central banks have the power to create new wealth out of thin air, simply by printing more money. In his words, “With regard to monetary policy, the view—or at least the suspicion—still persists in some quarters that an activist, expansionary policy could yield dividends in terms of permanently higher output and employment.”

In thinking about the limits of monetary policy, Greenspan was frank about the knowledge problem facing central bankers:

[There is no] bound volume of immutable instructions on my desk on how effectively to implement policy to achieve our goals of maximum employment, sustainable economic growth, and price stability. Instead, we have to deal with a dynamic, continuously evolving economy.… There is, regrettably, no simple model of the American economy that can effectively explain the levels of output, employment, and inflation. In principle, there may be some unbelievably complex set of equations that does that. But we have not been able to find them.

The complexity of the economic system precludes finding all the equations that would give perfect forecasts to guide Fed policymaking. The best we can do, argues Greenspan is to use “ad hoc partial models and intensive informative analysis to aid in evaluating economic developments and implementing policy.” But even here, the Fed’s forecasts of inflation and the real economy have been off the mark.

That is why Stanford economist John Taylor has long advocated a rules-based monetary regime. Likewise, Charles Plosser, former president of the Federal Reserve Bank of Philadelphia, has argued for placing limits on the central bank. In particular, he would narrow the Fed’s mandate to price stability, or at least make that the primary target; limit the Fed’s asset-acquisition activity to U.S. Treasuries; limit the Fed’s discretionary power “by requiring a systematic, rule-like approach” to policymaking; and limit the Fed’s authority to engage in credit allocation. Doing so, Plosser argues, would help maintain the Fed’s independence, improve policymaking, and promote accountability.

Central Bank Independence

Greenspan understood that the Fed is a creature of Congress and is ultimately responsible to it for maintaining whatever independence it has been delegated in implementing its mandates. However, he also recognized

that if the Federal Reserve’s monetary policy decisions were subject to Congressional or Presidential override, short-term political forces would soon dominate. The clear political preference for lower interest rates would unleash inflationary forces, inflicting severe damage on our economy.

Consequently, he emphasized that, “Our monetary policy independence is conditional on pursuing policies that are broadly acceptable to the American people and their representatives in the Congress.”

Foreseeing some of the issues written about by Paul Tucker in his book, Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State, Greenspan warned: “It cannot be acceptable in a democratic society that a group of unelected individuals are vested with important responsibilities, without being open to full public scrutiny and accountability.”

Rules versus Discretion

Greenspan valued the classical gold standard, which was a rules-based regime that brought about long-run price stability and constrained the fiscal hand of government. But, in a fiat money world, he leaned more toward a discretionary central bank than one subject to rigid rules. He thought that once the velocity of money became less stable, changes in the money supply became less reliable in forecasting nominal income. Therefore, a simple monetary rule was no longer of interest to the Fed: “Unfortunately, money supply trends veered off path several years ago as a useful summary of the overall economy.”

Nevertheless, Greenspan did not totally disregard the quantity of money in thinking about the conduct of monetary policy. He went on to say, “Still, if money growth is better behaved, it would be helpful in the conduct of policy and in our communications with the Congress and the public.” Of course, if the Fed had actually implemented a Friedman-style money growth rule and stuck to it, the velocity of money may have been more stable, and the link between money and prices more predictable.

After Paul Volcker tamed the double-digit inflation of the late 1970s and early 1980s, by restricting excess growth of money and credit, monetarism lost its luster among Fed economists—due to financial innovations that weakened the link between money and prices. Yet, Greenspan did temporarily (and implicitly) follow a monetary rule in the form of targeting total demand, measured by “final sales to domestic purchasers” (i.e., nominal GDP adjusted for the change in private inventories less exports plus imports). As William Niskanen explains, “a demand rule is potentially superior to a money-supply rule because it accommodates unexpected changes in the demand for money.” He shows that from 1992 to 1998, the Greenspan Fed kept nominal income (i.e., total demand) on a level growth path of 5.5 percent per year. Sticking to such a rules-based monetary regime—by constraining the growth of nominal income (total spending)—would help reduce uncertainty about the course of monetary policy and the price level, bringing about greater economic and social harmony. (It is also said that Greenspan, for a time, followed the Taylor rule.)

Conclusion

Much can be learned by reflecting on Greenspan’s 1996 speech, especially given the global financial crisis of 2007–2009 and the current pandemic—both of which have increased the Fed’s power and weakened its independence. There is still no monetary rule to guide monetary policy, even as inflation has reared its head once more. What jumps out from Greenspan’s speech is how he posed a problem that the Fed never solved, and then made things worse.

The New Year will test the Fed’s resolve to taper QE, “normalize” interest rates, and slow inflation. With unprecedented fiscal deficits and debt, at least in peacetime, there is a strong need to redelineate the distinction between fiscal and monetary policy—and to recognize the limits of monetary policy. Asking the Fed to do “too much” risks further politicizing the central bank, with the consequent loss of credibility.

Although Greenspan never formally adopted a monetary rule, he certainly understood the knowledge problem facing central bankers. Perhaps he might be more open to a rules-based monetary policy today, if he were to reflect on Karl Brunner’s insights regarding rules versus discretion:

Our life moves in a grey zone of partial knowledge and partial ignorance. More particularly, the products emerging from our professional work reveal a wide range of diffuse uncertainty about the detailed response structure of the economy.… A nonactivist [rules-based] regime emerges under the circumstances … as the safest strategy. It does not assure us that economic fluctuations will be avoided. But it will assure us that monetary policymaking does not impose additional uncertainties … on the market place.

Cryptocurrencies came under fire this fall when Congress identified the nascent industry as an opportunity to raise tax revenue. In just a few brief pages and two amendments to the Internal Revenue Code, Congress had what it needed to claim it secured $28 billion in expected tax revenue over the next ten years. But can taxing cryptocurrencies really add $28 billion to the government’s budget?

A spokesperson from the Joint Committee on Taxation (JCT)––the group that makes these estimates––confirmed that the data and methods used are generally kept confidential and not shared with the public. However, it might still be helpful to consider some of the more unique challenges that they may have faced in constructing the estimate––especially as legislators work on crafting amendments to the law.

Taxing What Doesn’t Exist

The most curious part about the cryptocurrency section of the Infrastructure Investment and Jobs Act is the suggestion that it will increase tax revenue while simultaneously setting a de facto ban on some of the legal activities it seeks to tax. To be fair, it is unlikely that the law will eliminate all cryptocurrency activity in the United States. Traditional brokers like Coinbase and Robinhood have most of the necessary information to comply with the law. However, on that note, it’s doubtful that the provision will create new revenue since these brokers already report information to the IRS and provide tax documents to users as part of their existing oversight.

Where the law may stand to gain additional revenue is in its requirement that cryptocurrency miners and software developers report information to the IRS. However, that activity is exactly what the law will likely eliminate because it mandates an impossible standard of reporting.

History has already shown that members of the cryptocurrency industry will not hesitate to vote with their feet. Kraken, Paxful, Bitfinex, BitQuick, BTCGuild, Eobot, Genesis Mining, GoCoin, LocalBitcoins, and Poloniex all left New York in 2015 in response to the state’s overbearing BitLicense. In a blog post at the time, Kraken wrote that the BitLicense “comes at a price that exceeds the market opportunity of servicing New York residents. Therefore, we have no option but to withdraw our service from the state.”

If the Infrastructure Act is left unamended, there is little doubt that much of the industry will be left with no option but to withdraw their services from the nation as a whole. In fact, that is exactly what happened earlier this year when the Chinese government cracked down on cryptocurrencies. The Chinese government declared both cryptocurrency transactions and cryptocurrency mining illegal. In the months that followed, “fourteen of the biggest crypto mining companies in the world [moved] more than 2 million machines out of China,” according to the Financial Times (See Figure 1 below for where some of those machines were sent).

Asking Too Much?

Although the JCT could not comment on their methods, it should not be too much to ask that the industry’s response be anticipated. In fact, the JCT has publicly confirmed that their models generally consider how taxpayer behavior might change. That involves considering “changes among the legal form of doing business” as well as “whether some types of taxpayers might more easily comply with its requirements than others.” Both considerations should have captured the likely exodus, but then that leaves the source of the expected tax revenue unclear.

Predicting the future is not a perfect science, but it can be improved through scientific methods. Chief among those is the spirit of transparency and citation. Something is clearly wrong if a bill with no public discourse can be made law and one of its key selling points is a claim with no evidence.

However, legislators should not let the challenge of dealing with the $28 billion estimate stop the conversation. Whether they try to craft an amendment that somehow keeps the estimate intact or an amendment that completely dismisses it, one thing remains clear: a single, un-audited estimation should not be the deciding factor for any policy––especially when it leaves so many questions unanswered.

Before they were awash with reserves, banks often paid interest to other banks in the “federal funds” market if they needed more reserves to support more lending (due to reserve requirements). Since 2008 and massive “quantitative easing” (buying federal debt with new reserves), reserve requirements stopped limiting commercial bank credit. The Federal Reserve instead paid an interest rate on reserve balances (IROB)– which effectively sets a floor under the fed funds rate.

Members of the Federal Open Market Committee, the Fed’s policymaking arm, announced on December 15 that their median projection for the fed funds rate would rise from 0.1% this year to 0.9% in 2022, 1.6% in 2023, 2.1% in 2024 and 2.5% over some “longer run.” It necessarily follows, under the post-2008 regime, that the Fed will be obliged to pay comparable interest rates on reserve balances – which is now the only rate presumably intended to restrain the flow of new bank deposits (money) created by new loans.

The announcement that the FOMC predicted (rather than planned) that the fed funds rate would be 4–8 basis points higher than they said in September was universally interpreted as a signal that the Fed would be “tightening” monetary policy. But that depends on some specific but unexplained theory and facts about how monetary policy works. If high inflation causes high interest rates, as Irving Fisher famously taught, it does not make much sense to expect high interest rates to cure inflation (which would lower nominal interest rates if it worked). The notion that a higher interest rates on reserves is per se evidence of “tightening” also depends on some theory and facts about whether the Fed leads or follows worldwide swings in inflation or interest rates.

The fed funds rate averaged 9.8% a year from 1980 to 1990. Was that because the Fed was following a “tight” policy to avoid inflation? Not if we judge policies by results.

The fed funds rate averaged less than 1.4% from 2002 to 2019. Was that because the Fed was following an “easy” policy to raise inflation? If so, it failed.

Japan has long had interest rates of zero or less, but inflation in consumer prices (unlike imported commodities) remains extremely low. Irving Fisher could explain that, but it defies defining high short-term rates as a weapon against inflation.

The new FOMC projections raised next year’s projected PCE inflation to 2.6%, up from 2.2% in September and from the CBO’s July estimate of 2.1%.

News of the Fed’s somewhat higher projected interest rates to be paid on bank reserves left the 10-year bond yield around 1.4–1.5%, so that trying to push the IROB higher than that might invert the yield curve enough to provoke a recession (which eventually pulls bank rates back down).

It is rarely prudent to assume that a central bank’s central planners can predict the future better than you can, or that they really know what they are doing and why.