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E-Money: Efficiency, Stability and Optimal Policy

  • Jonathan Chiu
  • Tsz-Nga Wong

What makes e-money more special than cash? Is the introduction of e-money necessarily welfare enhancing? Is an e-money system necessarily stable? What is the optimal way to design an efficient and stable e-money scheme? This paper provides a first attempt to develop a micro-founded, dynamic, general-equilibrium model of e-money for investigating these policy issues. We first identify some superior features of e-money which help mitigate informational frictions and enhance social welfare in a cash economy. A model that features both trading frictions and two-sided platforms is then built and used to compare two potential e-money schemes: (i) public provision of e-money with decentralized adoption, and (ii) private monopolistic provision of e-money. We show that, in general, both public and private provision of e-money are inefficient, and we characterize the optimal incentive scheme by addressing four potential sources of inefficiency – market powers in goods trading, network externality, liquidity constraint and monopoly distortion in e-money issuance. We show that the welfare impact of e-money depends critically on whether cash is a viable alternative to e-money as a means of payment. When it is not (e.g., for online payments where usage of money is prohibitively costly), the adoption of e-money is always welfare enhancing, albeit not welfare maximizing. However, when cash is a viable alternative (e.g., in a coffee shop), introducing e-money can sometimes reduce social welfare. Moreover, a system with public provision and decentralized adoption is inherently unstable, while a planner or a private issuer can design a pricing scheme to restore stability. Lastly, we examine an alternative e-money scheme – a hypothetical set-up with public provision through a private platform. We also compare the impact of various provision schemes on central bank seigniorage income. While this scheme may or may not improve efficiency, it can always increase seigniorage income, even though there may exist better policy options such as imposing a cash reserve requirement or collecting a charter fee.

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Paper provided by Bank of Canada in its series Working Papers with number 14-16.

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Length: 43 pages
Date of creation: 2014
Date of revision:
Handle: RePEc:bca:bocawp:14-16
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Web page: http://www.bank-banque-canada.ca/

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  1. Antoine Martin & Michael Orlando & David Skeie, 2006. "Payment networks in a search model of money," Staff Reports 263, Federal Reserve Bank of New York.
  2. Jean-Charles Rochet & Jean Triole, 2002. "Platform competition in two sided markets," LSE Research Online Documents on Economics 24929, London School of Economics and Political Science, LSE Library.
  3. Gautam Gowrisankaran & Joanna Stavins, 2004. "Network Externalities and Technology Adoption: Lessons from Electronic Payments," RAND Journal of Economics, The RAND Corporation, vol. 35(2), pages 260-276, Summer.
  4. Ben Fung & Miguel Molico & Gerald Stuber, 2014. "Electronic Money and Payments: Recent Developments and Issues," Discussion Papers 14-2, Bank of Canada.
  5. Narayana R. Kocherlakota, 1996. "Money is memory," Staff Report 218, Federal Reserve Bank of Minneapolis.
  6. Carlos Arango & Kim Huynh & Leonard Sabetti, 2011. "How Do You Pay? The Role of Incentives at the Point-of-Sale," Working Papers 11-23, Bank of Canada.
  7. Gans Joshua S & King Stephen P, 2003. "The Neutrality of Interchange Fees in Payment Systems," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 3(1), pages 1-18, January.
  8. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
  9. Jean-Charles Rochet & Jean Tirole, 2014. "Platform Competition in Two-Sided Markets," CPI Journal, Competition Policy International, vol. 10.
  10. Oz Shy & Zhu Wang, 2011. "Why Do Payment Card Networks Charge Proportional Fees?," American Economic Review, American Economic Association, vol. 101(4), pages 1575-90, June.
  11. E. Glen Weyl, 2010. "A Price Theory of Multi-sided Platforms," American Economic Review, American Economic Association, vol. 100(4), pages 1642-72, September.
  12. Monnet, Cyril & Roberds, William, 2008. "Optimal pricing of payment services," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1428-1440, November.
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