Page 6 - ISQ July 2021

INVESTMENT STRATEGY QUARTERLY

The Fed also made its employment goal broader and more Some cryptocurrencies, called ‘stablecoins,’ are tied to a hard
inclusive. It will look at a wide range of labour market indicators in currency (such as the dollar). Stablecoins improve payment
setting monetary policy. During its review, the Fed discovered that efficiency, speed up settlement flows, and reduce user costs, but
low unemployment is especially beneficial to lower-income they don’t offer the same protections as conventional payment
communities. systems, like your bank account.

The new policy framework is now being tested at a time of great The Fed has been studying the risks and benefits of CBDCs for several
uncertainty. Inflation is higher on a year-over-year basis, but that years now and will issue a discussion paper summarising its findings
partly reflects a rebound from the low inflation of a year ago (these this summer. Fed chair Powell indicated that “Our forthcoming paper
are called ‘base effects’). Production bottlenecks and materials on the evolution of digital payments is intended — along with our
shortages occur in economic recovery, but these difficulties are other work as a supervisor, regulator, and payment system operator
resolved over time. Pressures are more intense than usual now — to advance the objective of ensuring that the payments system
because this is a very rapid recovery. and the economy work for all Americans.”

Inflation expectations are a key driver of actual inflation. If workers
anticipate higher inflation, they are more likely to ask for wage IN CONCLUSION
increases and businesses are more likely to raise prices. Inflation Cryptocurrencies are not going away anytime soon, but they won’t
expectations have moved higher in the last few months, but have replace the dollar. Large fluctuations in value and high transaction
begun to moderate. The key is whether higher inflation expectations fees make them inappropriate for use in regular commerce.
are sustained – and we won’t know for sure until after the fact. CBDCs, tied to conventional securities like the dollar, are coming,
which will have many of the attractive features of these new types
While Fed officials believe that inflation pressures will prove to be of money, but will also provide better security and steadier value.
transitory, they are confident that they have the tools to bring
inflation down if we get a sustained increase in the underlying Electronic payments have been with us for a long time. In its early
inflation trend. days, the Federal Reserve ensured bank transfers made by
telegraph. Credit cards have advanced significantly and we can
CRYPTOCURRENCIES AND DIGITAL CURRENCIES now transfer funds using our mobile phones. In that sense, the
future is already here.
Cryptocurrencies, such as Bitcoin, Ethereum, and Dogecoin, are
digital assets, using distributed ledger technologies, such as
blockchain, to secure transaction records and verify transfers.
They are an elegant solution to no particular problem with KEY TAKEAWAYS:
conventional money. • These days, the concept of money includes much more
than hard currency. In fact, paper currency and coins
The use of cryptocurrencies as a medium of exchange is limited.
They can be used to buy a small number of goods and services and account for a tiny fraction of transactions.
transaction fees tend to be high. They may store value, but as • The Fed now has an average inflation targeting system.
we’ve seen, that value can change dramatically from day to day. To The long-term inflation goal remains at 2%, but
date, cryptocurrencies have not served as a convenient way to following a period of inflation below 2%, the Fed will
make payments. pursue a period of inflation above 2%.
Critics have likened cryptocurrencies to a pyramid scheme and • While Federal Reserve officials believe that inflation
point to a number of negatives. They are used widely in money pressures will prove to be transitory, they are confident
laundering, the illegal drug trade, and other criminal activities (but that they have the tools to bring inflation down if we
then again, so is paper currency). A lot of energy is used in mining get a sustained increase in the underlying inflation
new cryptocurrency, adding to concerns about climate change. trend.
• Cryptocurrencies are not going away anytime soon,
Digital currencies, including cryptocurrencies, are money in
electronic form. Central Bank Digital Currencies (CBDC) are (or will but they won’t replace the dollar.
be) issued by a central bank. China has a digital Renminbi, but
most other central banks are still studying CBDCs. As part of the
money supply, CBDCs will still be a fiat currency, but will offer
security in transactions and transfers.

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