Bank of Canada contemplating negative interest rates, powered by e-money, or bitcoin

Following in the footsteps of several European countries, the Bank of Canada has officially begun to explore the limitations of conventional monetary policies and systems, and expressed their optimism in a cashless society, an economy completely run by e-money, or digital currencies such as bitcoin.

Earlier this year, the Central Bank of England hinted at the possibility that the U.K. government may issue its own blockchain-based cryptocurrency, while George Galloway, a London Mayoral Candidate proposed MayorsChain, a blockchain-based public expenditure management system.

"While existing private digital currencies have economic flaws which make them volatile, the distributed ledger technology that their payment systems rely on may have considerable promise. This raises the question of whether central banks should themselves make use of such technology to issue digital currencies.”
—  – Bank of England, One Bank Research Agenda

The Bank of Canada is taking a slightly different approach. Instead of disbursing a sizable portion of its research fund to design its own payment protocol or decentralized transaction network, the bank is studying bitcoin itself, as an alternative currency. While the bank believes in the potential of e-money, they are in search of a store of value that could create a new dynamic in the global monetary order.

"We have to envisage a world in which people mostly use e-money, perhaps even one that’s not denominated in the national currency, like Bitcoin," said the Central Bank’s second-in-command Carolyn Wilkins.

"This would create a new dynamic in the global monetary order and one in which central banks, quite frankly, would struggle to implement monetary policy."
— – Carolyn Wilkins, Bank of Canada Senior Deputy Governor

The growing interest in bitcoin and alternative digital currencies from the Canadian government stems from its history of being a monetary policy innovator, Wilkins explains. Since 1991, the Bank of Canada has implemented financial systems to handle rising inflation rates, and the declining value of its currency.

One of the financial frameworks that the Bank of Canada adopted in the ‘90s, which others perceived as “unworkable,” was the inflation-control target, which attempts to maintain the Consumer Price Index (CPI) inflation at 2% over the medium term, by raising or lowering central bank interest rates.

Inflation targeting was pioneered by New Zealand in 1990, with Chile adopting a target in 1991. Inflation targets have now been adopted by central banks in the United Kingdom, Canada, Czech Republic, Australia, South Korea, Egypt, South Africa, Iceland, Brazil,and the Philippines, among other countries.

The adoption of this inflation-control target allowed the Bank of canada to stabilize the CPI, the most relevant estimate of the cost of living for most Canadians. The Index represents the real value of wages, salaries, pensions and monetary magnitudes.

Over the past decade, the total CPI of Canada has recorded a mere 16.1% increase, establishing itself as one of the most stable economies and currencies in the world, “Canada was fortunate to avoid the worst of the (2007-09) crisis, thanks to the relative strength of our economy, our prudently managed and resilient financial system, and well-anchored inflation expectations,” explained Wilkins.

However, in its newly released research paper, the Bank of Canada ponders the potential of implementing negative central bank rates.

"To the extent that policy interest rates can be reduced meaningfully below zero temporarily with limited costs to financial stability, arguments that the inflation target should be raised in response to a lower neutral interest rate become less powerful, particularly given the costs that permanently higher inflation poses."
— – Wilkins

Negative interest rates impose a charge on clients holding funds in a bank account. Andrew Haldane, Bank of England Chief economist and Executive Director, explained the difficulties in a recent speech. “It is possible to set negative rates on bank reserves – indeed, a number of countries recently have done so. But without the ability to do so on currency, there is an incentive to switch to currency whenever interest rates on reserves turn negative.”

“In one sense, there is nothing new about digital, state-issued money. Bank deposits at the central bank are precisely that. The technology underpinning digital or crypto-currencies has, however, changed rapidly over the past few years. And it has done so for one very simple reason: Bitcoin.”
— – Andrew Haldane, Bank of England Chief Economist

Sweden, the latest country to implement negative policy rates, is experiencing exactly this problem. Under extreme conditions, the central bank of Sweden is now charging to hold bank deposits, the current Swedish interest rate Riksbank (base rate) is -0.350%.

Residents have reportedly been keeping cash at home, to avoid the charges. The former head of Sweden’s national police told The Local, "I’ve heard of people keeping cash in their microwaves because banks won’t accept it."

The lure of a cashless society, for central bank economists, is a lack of physical money to keep in microwaves. Haldane describes a “radical proposal” to abolish paper currency  altogether, “it has the added advantage of taxing illicit activities undertaken using paper currency, such as drug-dealing.”

While Sweden is closer to becoming a cashless society than any other country, there are some major challenges to overcome first. Those who are familiar with cash, and those who don’t have access to other options, cannot be discriminated against.

“A recent survey I worked on showed that two-thirds of Swedes think carrying cash is a human right,” Niklas Arvidsson of Sweden’s Royal Institute of Technology told Bloomberg. “We like having our own currency and it fits in with the identity of being a Swede; we’re even releasing new banknotes in 2015. So people like to know their cash is there, even if they don’t necessarily use it.”