Do stablecoins present any significant problems for monetary policy? Consider this discussion in a recent Conversations With Tyler:
DIXON: I think you’re going to have every bank probably issuing, I hope, a stablecoin the way you have them issuing credit cards. These all have users and customers. The banks will have a button that says, “Send a stablecoin.” What I’m hoping is that there’re enough legitimate actors around this who create a network effect that, to your point, yes, there will be that stuff, but it will be marginalized.
COWEN: In that world, should we infer that the Federal Reserve loses control of the money supply? Create a stablecoin. It’s backed by a T-bill. In a funny way, it’s like a private open-market operation. I’m fine with that. I’m not sure the Fed controls the money supply today. Does that become a macro issue?
DIXON: I feel like I’m talking to a famous economist. [laughs] I’m on your territory now. It’s dangerous because I’m not an economist.
COWEN: Well, I haven’t figured this out myself either, to be clear. I’m genuinely asking various people. I asked Austan Goolsbee the same question because I don’t know.
In a recent post, Tyler said the following:
The AI is your smartest reader. It’s your most sympathetic reader.
So why is he asking “various people”? Why not ask an AI? I suspect the answer is that “smartest” can be defined in many ways, and while the top AIs are the smartest in many respects, they are not the smartest in the most challenging areas. I asked ChatGPT about this issue, and its answer is far inferior to the one I’m about to provide. (I’m being a bit mischievous here. Tyler’s right that AIs are smarter than me on the vast majority of questions—but not in areas where I have expertise.)
So here’s my answer: Stablecoins do not present any problem for monetary policy. The Fed will still control the monetary base, and they have almost unlimited ability to adjust both the supply and the demand for base money. This means they will be able to react to the creation of money substitutes as required to prevent any impact on macroeconomic objectives such as employment and the price level.
The Fed can directly control the supply of base money through open market operations, that is, the purchase and sale of Treasury securities. That’s all the power they need to completely offset the impact of stable coins on the demand for base money. But they have an additional powerful tool that also impacts the demand for base money: interest on bank reserves. With these two policy tools, the Fed has the technical ability to move the price level to any position they like. Of course, political considerations would preclude the Fed engineering any extreme move up or down in the CPI, but that’s not an issue when the Fed is trying to stabilize the price level in the face of growing use of stablecoins.
BTW, some of my views on monetary policy are controversial, and not accepted by the experts. I don’t believe that my view on this particular issue is at all controversial, unless base money demand fell to zero. This seems quite unlikely, especially as the stablecoins will probably need to be backed by some form of government money, and at least some cash will continue to circulate.
PS. Contrary to popular opinion, demand for currency has not declined even as we’ve moved to a “cashless economy”. Currency demand, even as a share of GDP, is higher today than it was 100 years ago, when people routinely used cash to make purchases. That’s because increased government regulation (i.e., the war on drugs, etc.) and higher taxes have caused the demand for currency as an anonymous store of value to rise much more rapidly than the transactions demand for currency has declined.
Conceivably, the recent slowdown in currency demand growth might be partly due to stablecoins, but more likely it reflects the fact that much higher nominal interest rates since 2022 have increased the opportunity cost of holding zero interest currency as a store of value.
