Book Chapter | October 16, 2006

The Evolving Payments Landscape And Its Implications For Monetary Policy

By: Sujit Chakravorti
Source: Institutional Change in the Payments System and Monetary Policy, editors Stefan W. Schmitz and Geoffrey E. Wood

While the literature on the economics of exchange and the role of money is rather extensive, economists have devoted less time linking the evolution of the payment system and its potential implications for monetary policy. A smooth functioning payment system is vital for effective implementation of monetary policy. The key questions that this chapter asks are: (1) How is the payment system evolving? (2) What are the economic forces driving the adoption of new payment instruments? (3) Would recent developments in the payment system limit the central bank from conducting monetary policy?

Large-value payment systems migrated to electronic systems in advanced economies many years ago and account for the bulk of the total value of payment transfers. However, large-value payments account for a small proportion of the total number of payment transactions. On the other hand, the migration from paper payments to electronic substitutes has been significantly slower for small-value or retail transactions in many advanced economies. Today, more and more payments are made via payment cards that either debit a customer’s transactions account at financial institutions or access a line of credit extended by a financial institution or a merchant. Transactional use of currency along with checks continues to decline in most advanced economies.

More recently, stored-value cards, usually plastic cards similar in size to credit cards, are able to mimic many characteristics of money. In this chapter, stored-value cards will be defined as cards where the monetary value is recorded on the card and online verification is not necessary for the transaction to be completed. While the adoption of general-purpose stored value cards has been slow, stored value has been successfully adopted for closed-loop systems such as university campuses, military bases, and transportation systems. Financial institutions along with merchants have started to consider expanding closed-loop payment mechanisms to a wider class of merchants.

This chapter will discuss recent trends in payment systems, study the economic forces underlying the adoption of new payment instruments, and explore the effects of these changes for monetary policy. Recent payment trends indicate a migration away from currency and checks towards electronic payment alternatives. This chapter will review the recent economics literature that builds upon the network economics literature to study the underlying factors driving the adoption of new payment instruments. While countries are at different stages in the migration to electronic alternatives, this shift has not affected the ability of central banks to conduct monetary policy. In this chapter, I argue that the migration to cash substitutes will not impact monetary policy unless final interbank settlement of most transactions occurs in non-central bank issued reserves. Furthermore, if the central bank maintains price stability and provides sufficient quantities of currency, the likelihood of its currency not being the generally-accepted medium of exchange is negligible. In the next section, a description of payment systems and recent trends are discussed. In the third section, the economics of emerging payment instruments is discussed. In the fourth section, the impact of the rise on electronic substitutes on transactional cash usage is investigated. In the fifth section, the impact of recent developments in payment systems and its implications for monetary policy are explored. Finally, the last section concludes the chapter.

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