Why the Fed is wrong about Libra
The Federal Reserve Act (FRA) requires the Chairman of the Federal Reserve System to testify before the House Financial Services Committee and the Senate Banking Committee twice a year, in February and July, on how the Board handles monetary policy and its observations on economic developments.
In keeping with that requirement, the current Chairman of the Federal Reserve, Jerome Powell, testified before the House on July 10th. He indicated as follows:
- Economic activity increased at a solid pace in the first part of 2019. The labor market has continued to strengthen: unemployment fell from 3.9% (Dec) to 3.6% (May), wage gains remained moderate.
- Inflation has been running below the Federal Open Market Committee’s (FOMC) longer- run objective of 2 percent.
- In June, the FOMC judged that current and prospective economic conditions called for maintaining the target range for the federal funds rate at 2 1⁄4 to 2 1⁄2 percent.
- Inflation: Consumer Price Index = 1.5 (May).
- Economic Growth: 1st qtr Gross Domestic Product, the total of all goods and services produced over the quarter, increased at an annual rate of 3.2%.
- Financial Conditions: Treasury yields down, loans remain widely available to most homes.
- Financial Stability: Borrowing by businesses outpaces GDP, risks in the financial system remain low relative to pre-financial crisis, banks hold large quantities of assets.
Chairman Powell discussed Libra, Facebook's proposed digital currency and feels the currency poses special challenges to the Fed’s dual mandate of low inflation and maximum employment. We think the Fed is attempting to diminish Libra in particular and crypto markets in general by tying their objections to the Fed's social mission (maximum employment) and placing Libra in the category of having negative social return. We know this is likely false.
House Financial Services Committee Chairwoman Maxine Waters maintained that the bank regulatory system lacks the capacity to control Libra (she is correct), and reiterated her call for a moratorium on Libra's development (she is incorrect - see: Regulating Libra’s a waste of time. https://www.americanbanker.com/opinion/regulating-libras-a-waste-of-time). House Financial Services Committee Ranking Member McHenry used the hearing to, once again, state that Libra poses a risk to financial stability,
While Chairman Powell: indicated he thought Libra posed risks due to the possibility of broad adoption and of money laundering, he stated that Facebook's proposed currency offers financial inclusion benefits.
Mr. Powell also indicated that the Fed's control over money supply and demand allows it (the Fed) to appropriately respond to major economic disturbances. This is not what happened in the years leading up to the last financial crisis, and is not likely to be true now, in the months leading up to the next crisis.
The Chairman is correct in saying that if a cryptocurrency becomes widely used and viable, this would adversely affect the Fed's conduct of monetary policy. As another form of currency becomes used widely for payments, a central bank loses its absolute monopoly on controlling inflation and inflation targeting through manipulating cash in the system. There are, however, other ways to control monetary aggregates and inflation. Thus, there are other tactics the Fed could use to maintain control over monetary policy. (We discuss these in our paper, Monetary Policy under Cryptocurrency.)
(Research provided by Willem Sheetz, Impact Investing Analyst, University of Wisconsin (Madison))