Yves Mersch: Central banking in times of technological progress
Speech by Mr Yves Mersch, Member of the Executive Board of the European Central Bank, at
the Central Bank of Malaysia (Bank Negara Malaysia) Monetary Policy Conference, Kuala
Lumpur, 24 July 2017.
* * *
There have been many significant advances in technology over the three and a half centuries that
central banks have existed: railways, electrification, computerisation, and the internet to name
but a few. Each of these great waves of technological revolution has transformed how
economies function. While not all have had such a marked impact on central bank operations,
we have nonetheless changed a great deal over the past 350 years, and should expect to do so
in the future.
Given the uncertain impacts of technology, central banks should react prudently, and in the same
forward-looking fashion that we implement policy. In my mind, there are three key responses of
central banks to technology:
adapt our policies to take into account technology-driven changes in the real world,
adopt appropriate technology that enables us to best carry out our functions. As I will
highlight throughout my remarks today, appropriate does not always mean the newest or
most fashionable technology. Each new advance must be carefully and prudently assessed
for its potential impact.
anticipate technological risks to our operations.
With these three key responses in mind, I will consider the challenges - and opportunities -
arising from technology to our mandate for price stability, central banks' role in payment
systems, and safeguarding our operations in the internet age.
Price stability
The first important consideration for monetary policy relates not to any particular technology, but
to the overall rate of technological progress. As the technological frontier shifts outwards, and
that knowledge diffuses across the economy, overall productivity increases. That increased
productivity affects the rate of return on investment and hence the level of real equilibrium interest
rates.
Since monetary policy aims to vary short-term real rates around that equilibrium to meet our
price stability mandate, changes in the overall rate of technological progress affect the interest
rates central banks set. As such, policymakers need to adjust policy settings to adapt to changes
in the real economy.
Setting policy according to a fixed rule with pre-determined coefficients on inflation and the output
gap is at the best of times likely to lead to sub-optimal policy settings, given the uncertainties in
measurement of the output gap. But in times of technologically driven changes in economic
relationships, such a rule could potentially result in interest rates that are wholly inappropriate for
the economy and inconsistent with our mandate for price stability.
Yet that is not to say that different policy tools are all inappropriate. The past decade has posed a
number of challenges for policymakers. For some observers, there appears to have been a
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secular fall in measured productivity growth and equilibrium real rates across advanced
countries. Lower equilibrium rates reduce the room for manoeuver that central banks have to
lower rates and still remain above the effective lower bound. Other observers attach more
attention to measurement of productivity changes due to technological progress and globalisation
and hence warn against hasty changes to targets and objectives.
At the same time, interbank markets in the euro area became fragmented along national lines
during the crisis, threatening the transmission of monetary policy.
The various so-called unconventional monetary measures undertaken by the ECB and other
central banks throughout the crisis are a good example of adapting policy to changes in the real
economy. Forward guidance, asset purchases, negative nominal interest rates and lending
schemes that incentivise banks to increase lending, such as the targeted longer-term refinancing
operations, were all designed to combat the challenges of the period. Such policies were seen
as appropriate - being both necessary and proportionate responses by central banks to fulfil their
mandate for price stability. But as conditions normalise, it is unlikely that these policies will
remain necessary.
While my comments so far about technical progress in aggregate reflect a perennial challenge
for central banks, current technological progress poses a particularly acute challenge because of
its direct impact on the price-setting behaviour by businesses that underlies the inflationary
process. Improvements in logistics have permitted the growth of global value chains, and
ecommerce has revolutionised the transparency of pricing within and across countries. These
technological advances can affect how domestic inflation reacts to shocks, the pass-through of
exchange rate movements into inflation and the domestic impact of global developments and
inflation.
These factors pose their own issues for the measurement of inflation. While that generally falls
under the jurisdiction of statistical institutes, central banks have clear interest in engaging with
methodological decisions given our mandate for price stability. Without wishing to devote too
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much time to technical details of index construction, allow me to highlight some of the issues.
Technological progress has resulted in the creation of products such as smartphones and
internet service providers that had no equivalent in the past. And the conceptual foundation of
inflation being the annual change in prices is challenged when some electronic articles have a
shelf-life of less than a year. This is particularly true when part of the consumption value of the
good in question is being the latest edition. Heavy discounting of the now less fashionable older
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editions could create downward bias in traditional indices.
Similarly pricing online services poses a number of challenges. For example, in the past
consumers would buy premade package holidays from a travel agent. Nowadays, online
services permit households to create their own packages. This task is more and more
outsourced by the agencies, i.e. they reduce their cost; and accepted by the customers.
Measuring - and pricing - the value of that service is not always transparent. This complicates
the proper inclusion of the economic activity undertaken into national accounts. Indeed, in the
absence of a measurable transaction, it would normally be beyond the scope of consumer price
indices.
Some internet services do not even have a monetary charge, but customers pay via providing
data - sometimes without being aware of the full extent of their payment. Search engines and
other portals are nominally for free, but create revenue through advertising, paid ordering of
search results and commissions from linking customers to businesses.
A further challenge for price indices arising from internet sites is their ability to tailor individual
prices to the consumer - two people looking at the same website at the same time may be
offered two different prices. As indeed does the speed at which prices change. It was not that
long ago that a hotel would post its prices for the year ahead and leave them fixed, whereas now
hotels dynamically manage occupancy through changing room prices perhaps even several
times in one day.
Of course, change in consumption habits and expenditure patterns are not a particularly new
problem for statistical agencies to deal with. It has long been recognised that regularly updating
weights and the goods and services included in the basket results in an index that better
describes the prices faced by consumers. Consumer price indices, including the Harmonised
Index of Consumer Prices used in the euro area, have already made large strides in adapting
their methodology to account for changes in technology.
And technology has itself been a benefit in price collection. Gone are the days of price collectors
walking through shops with a clipboard with reams of paperwork requiring multiple input steps.
Price collection on the ground is now carried out with electronic tablets directly updating
databases, and the opportunity to use web scraping technology has facilitated a much cheaper
and widespread source of price quotes. Research can now be carried out on data sets not of
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hundreds of price quotes, but of a billion. The use of scanner data has enabled a much greater
idea of not only more granular purchases, but also seasonality in purchases.
But the technological changes to price and wage setting behaviour have much deeper relevance
for central banks than just the measurement of inflation. The speed and extent that inflation
reacts to shocks - both domestic and global - affects the optimal response of monetary policy to
those shocks. Allow me to give a few examples of how technology can affect the price-setting
process and the economy's reaction to shocks, focusing on e-commerce.
E-commerce can erode the monopolistic and monopsonistic power of suppliers of goods and
services, reducing mark-ups. Such a change in mark-ups can be viewed as a flattening of the
Phillips curve, meaning a given change in the output gap has a weaker impact on inflationary
pressures. Conversely, e-commerce may result in suppliers changing prices more
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frequently. As I mentioned earlier, there is certainly evidence of this happening in certain
sectors. Partly this is due to lower menu costs for producers, but also lower search costs for
consumers increases the likelihood of them switching supplier and hence increases the
opportunity cost of being away from the optimal price. More frequent price changes result in a
steeper Phillips curve - prices react more quickly and stronger to changes in output.
At the same time, e-commerce may restrict the ability of businesses to set prices that deviate
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substantially from those of large online retailers. So prices may change more often, but there
may be a greater clustering of prices, which in turn may restrict the ability of prices to reflect
idiosyncratic shocks. Furthermore, the dominance of certain online retailers, which may
potentially be reinforced by the algorithms of search engines, may lead to market power and
stifling of competitive forces over the longer term.
Overall, the impact of e-commerce on the slope of the Phillips curve is uncertain, and studies
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have in general struggled to find large effects on annual inflation. Given the overall difficulty in
estimating the slope of the Phillips curve, this is not entirely a surprise. And beyond just
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ecommerce, the development of global value chains facilitated by technology could potentially
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change the influence of global inflation factors on domestic inflation and the degree of
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exchange rate pass-through.
As with the measurement of consumer price indices, the greater availability of more granular
data has enabled a much greater understanding of how businesses set prices. But while
policymakers should adapt policy to take into account changes in the underlying price-setting
process, we should exercise due prudence, given the range and uncertainty surrounding model
estimates.
And the effects of technology run deeper than just price setting. Email, videoconferencing,
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secure VPN connections, and outsourcing across countries enable services to be provided
from distance, and permit a greater degree of flexibility in working practices. It is a notable
socioeconomic shift in the interaction between employers and employees.
In the labour market the internet allows for more services being offered with less intermediation
at lower prices. Fragmentation of labour time is shown in the diverging results of compensation
per employee and compensation per hour worked.
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For some workers this is a positive development, allowing them to participate in the workforce
where previously they may have been unable. But for others, the greater individualisation of roles
can lead to insecurity, in turn affecting households' income and spending. More individualised
roles can also weaken the ability of collective bargaining to maintain the labour share of
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income. These changes combined could lower the NAIRU, changing the Phillips curve
relationship between unemployment and wage pressure, and hence how monetary policy should
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react.
Payment systems
The second area where I wanted to discuss the impact of technology on central banks is that of
payment systems. Let me begin with cash, something that central banks have issued since their
inception. For cash to carry out its roles as a medium of exchange and store of value, the public
has to have trust in its integrity.
To maintain that integrity and protect the currency from counterfeiters, central banks have for
centuries not only adopted innovations at the cutting edge of printing technology to protect their
notes from counterfeiting, but actively driven innovation in that area. Our latest €50 note - issued
earlier this year - is no exception, incorporating an enhanced range of security features. Such
technological adoption is wholly appropriate in this case, where ceding the technological high
ground to criminals risks undermining the currency.
Cash is the only central bank liability available to the public. It maintains a tangible link between
the general public and the central bank, a link which is important for maintaining trust between
the two. Of course, several private sector payment instruments and systems are already well
established: credit cards, direct debits and online payments to name but a few. More recent
developments include payment methods based on smartphone technology, mobile wallets and
investigations into the use of distributed ledger technology.
These technological developments have encouraged some to argue for the abolition of cash.
Broadly speaking, those arguments fall into three camps: overcoming the restrictions on
monetary policy arising from the zero lower bound, frustrating the actions of criminals by
eliminating the primary means of illicit payments and reducing the high costs of cash storage,
issuance and handling faced by the financial sector.
I have to admit some scepticism about these arguments. The various unconventional measures I
mentioned earlier that central banks put in place during the past decade have proven sufficient to
meet the challenges of low inflation and low equilibrium rates. The United States has already
begun to tighten policy. In the euro area, while our cycle is further behind, we already witness a
broad-based and resilient recovery.
While being able to set significantly negative rates may work smoothly in an economic model, I
am less certain how the public would react, particularly given the experience of millennia of
positive nominal rates. Not only would such rates be deeply unpopular, there may be unintended
changes in behaviour that would dampen the effectiveness of the measure.
Given the overall level of uncertainty of data and economic models, policymakers should act in a
prudent fashion and only take actions that are necessary for the fulfilment of the price stability
mandate and proportionate to the challenge in hand. To my mind, the abolition of cash for
monetary policy purposes does not pass the appropriateness test.
In terms of the cost savings from new technologies such as the distributed ledger, I would again
add caution. Far more detailed research is needed into the most beneficial system for all parties,
and not just for financial institutions. As just one example, suppose central banks stopped
providing cash and instead shifted to just providing Digital Base Money (DBM) - an electronic
claim on the central bank. Would the system involve each individual having an account at the
central bank, or involve a decentralised system where each individual has an electronic wallet
and the central bank is unaware of transactions that take place. Either system could be
implemented using a distributed ledger, but the set up would be quite different in each
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scenario.
In any case, just as cash has a number of technological safeguards to protect from
counterfeiting, DBM would require significant safeguards to protect individuals from theft and
from loss of personal information. Prudence should underpin our decision on what technology to
adopt. Adopting untried technology that ultimately proves unreliable could seriously endanger
public trust in the currency and in the central bank. Any new payments system technology should
be rigorously tested before implementation, with due regulation and oversight thereafter.
As to the often stated link between cash and illicit payments, there is no evidence. Even the
available anecdotal hints attribute only a relatively minor role to illicit activity compared to the
overall honest use of cash as a private means of payment.
Moreover, for all the buzz currently surrounding new payment technologies, it is worth noting that
cash, despite having been around for millennia, still remains popular. In the euro area, around
80% of transactions at point of sale are carried out in cash, and cash transactions account for
around half the total value. For now, provision of physical cash remains an important role for
central banks.
There may be a time in the future when the general public favour electronic money. Cash
transactions are already a minority in some countries. In that future time, it would be appropriate
for central banks to adopt technology that best reflects the general preferences of the population.
It is not our role to drive technological adoption in the general public, but to enable changing
preferences to be fulfilled in a secure fashion. For that reason we test new technologies in
laboratory environments with an array of partners.
Safeguarding our operations
Security is the final area I wish to consider today. What steps need to be taken to safeguard our
operations from technological risks?
Banknotes and payment systems are not the only areas where technology creates risk for public
trust in the central bank. Traditionally we have maintained strong physical security measures to
protect our gold and currency reserves. In 1781, the Bank of England acquired and subsequently
tore down the adjacent church St Christopher le Stocks, fearing that the spire could be seized by
rioters and used as a platform to attack the Bank.
As a result of technology, potential attacks on central banks extend beyond the physical realm
and can be launched from much further away than the building next door. Thick walls of a
different kind are required to protect our valuable data from technological incursions. Recent
examples of such incursions include payment systems being accessed and substantial funds
being transferred; suspicions - since proven unfounded - of financial market trades occurring on
the basis of hacking the electronic link between the central bank and newswires; sensitive
information being emailed accidentally to outside sources; and journalists breaking embargo on
interest rate decisions.
Central banks are also vulnerable to more generalised technological risks. There have been a
number of recent examples of computer virus outbreaks that have simultaneously disabled
computer networks across a range of institutions in several countries. Were such a virus to
affect the central bank's own network, there would be considerable operational risk. Similarly, the
smooth functioning of payment systems could be threatened if those servers were affected.
Faced with this range of threats to our operations, central banks should regularly assess
potential risks, and take measures to anticipate them. Anti-counterfeiting measures incorporated
into our banknotes are designed to foil the most sophisticated counterfeiters. Measures put in
place to protect our information should likewise aim to foil the most sophisticated assailants.
Adopting the latest technological advances in security is not only appropriate, but vital.
Conclusion
Allow me to conclude.
Technological change is an integral driver of economic development. It is disruptive at times and
impacts not only economies but also our societies. Central banks are not isolated from these
processes.
Central banks are well advised to be prudent and forward-looking when approaching the
respective challenges - just as they are when implementing monetary policy to honour their
mandates.
Facing the uncertainties of technological change, central banks therefore should
1. adapt policies to take into account technology-driven socio-economic changes,
2. adopt appropriate technology that supports the various functions and tasks of a central
banks, and
3. anticipate technological risks to our operations.
With these principles in mind, central banks can better manage the challenges stemming from
technological change, even when it is disruptive. Used appropriately they can even help to
improve our operations and efficiency.
1
See, e.g., Gordon, R. (2016), The Rise and Fall of American Growth: The US Standard of Living since the Civil
War, Princeton University Press. It is worth noting that others contest the slowdown, arguing it relates to
measurement error, e.g. Brynjolfsson, E. and A. McAfee (2011), Race Against The Machine: How the Digital
Revolution is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the
Economy. Digital Frontier Press.
2
See, e.g., evidence presented in Constâncio, V. (2016), "The challenge of low real interest rates for monetary
policy", Lecture at the Macroeconomics Symposium, Utrecht School of Economics, 15 June.
3
For a more detailed analysis of issues relating to index calculation, see Diewert, W. E. (1998), "Index Number
Issues in the Consumer Price Index", Journal of Economic Perspectives, 12(1): 47-58 and von der Lippe, P.
(2007), Index Theory and Price Statistics, Peter Lang, Frankfurt am Main.
4
The direction of the bias for the aggregate index is less certain. Broda, C. and Weinstein, D. (2010), "Product
Creation and Destruction: Evidence and Price Implications", American Economic Review, 100 (3): 691-723, find
that failing to take into account product creation across the index creates an upward bias to traditional "fixed
good" indices.
5
Cavallo, A. and R. Rigobon (2016), "The billion prices project: using online prices for measurement and
research", Journal of Economics Perspectives, 30(2): 151-78.
6
Gorodnichenko, Y. and O. Talavera (2014), "Price setting in online markets: basic facts, international
comparisons and cross-border integration", NBER Working Paper, No. 20406.
7
Cavallo, A. (2017), "Are online and offline prices similar? Evidence from large multi-channel retailers", American
Economic Review, 107(1): 283-303, finds price levels are identical around 72% of the time.
See, e.g. Lorenzani, D. and J. Varga (2014), "The economic impact of digital structural reforms", European
Commission Economic Papers, No. 529.
9
For a more detailed discussion of the impact of global value chains see ECB (2017), "Domestic and global
drivers of inflation in the euro area", Economic Bulletin, Issue 4 : 72-96.
10
Ciccarelli, M. and B. Mojon (2010), "Global Inflation", The Review of Economics and Statistics, 92(3): 524-535
find that a large proportion of domestic inflation rates in 22 OECD countries can be explained by global factors.
Parker, M. (2017), "Global inflation: the role of food, housing and energy prices", Working Paper Series, No 2024,
ECB, extends the analysis to a much larger sample of 223 countries and territories, showing the influence is
particularly strong in food and energy prices.
11
For example, Amiti, M., Itskhoki, O. and J. Konings (2014), "Importers, exporters and exchange rate
disconnect", American Economic Review, 104(7): 1942-78, find that larger shares of imported intermediates in
production influence the degree of price pass-through from exchange-rate movements.
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Virtual Private Network.
13
Bloom, N., Liang, J., Roberts, J. and J. Zichun (2015), "Does working from home work? Evidence from a
Chinese Experiment", Quarterly Journal of Economics, 130(1): 165-218 find a 13% increase in productivity of
workers who work from home.
14
International Monetary Fund (2017), "Understanding the downward trend in labor income shares", IMF World
Economic Outlook, April.
15
NAIRU = Non-accelerating inflation rate of unemployment. The NAIRU refers to a level of unemployment below
which inflation rises.
16
For a more detailed discussion of the impact on wages, see Haldane, A. (2017), "Work, wages and monetary
policy", Speech at the National Science and Media Museum, Bradford, United Kingdom, 20 June.
17
The issues surrounding DBM are discussed in more detail in Mersch, Y. (2017), "Digital Base Money: an
assessment from the ECB's perspective", Speech at the Farewell ceremony for Pentti Hakkarainen, Deputy
Governor of Suomen Pankki - Finlands Bank, Helsinki, 16 January.