Academic journal article Federal Reserve Bank of Minneapolis Quarterly Review

Money and Debt in the Structure of Payments

Academic journal article Federal Reserve Bank of Minneapolis Quarterly Review

Money and Debt in the Structure of Payments

Article excerpt

An aphorism in economics is that money exchanges for goods, and goods for money, but goods do not exchange for goods. However, if one interprets money to mean base money or other outside money (such as balances held at a central bank), then the aphorism's simple pattern of money-for-goods exchange hardly captures the structure of actual transactions. The goals of this study are to understand the structure of transactions more closely and to address two major issues regarding it.

Notwithstanding the dissimilarities among various payment arrangements at a fine-grained level, most such arrangements have two main structural features in common. First, with few exceptions (such as cashiers checks and some wire-transfer networks based on real-time gross settlement), payment arrangements involve the creation of short-term debt of the payor to the payee that is settled through intermediaries. Second, although incurring short-term indebtedness is a substitute for using money for the purchase of a good, these debt-based arrangements do not wholly replace money, because money is used to settle the debt.(1)

Specifically, then, this study concerns payment arrangements based on intermediated debt that is settled using money. Such arrangements include checks, wire-transfer systems with netting arrangements, credit cards, and the like. The two features emphasized here lie at the root of current discussions regarding welfare and policy aspects of the payment system. Regarding large-value payments especially, there is controversy over whether or not the creation of debt is a desirable feature of a payment system. Given that there is a feasible way to make a cash transaction or to achieve gross settlement of an electronic transaction in real time, it is not obvious what the gain is from making payments in a way that involves creation of debt at an interim stage. In practice, the creation of debt carries at least a small risk of inability to settle, so one would not choose arrangements involving netting or other forms of debt creation if cash or gross-settlement arrangements were equally good in other respects. To the extent that the concentration of this debt in the possession of an intermediary should be cause for additional concern, this argument becomes even more persuasive. In order to make a good case for payment-system arrangements involving intermediated debt, therefore, some specific benefit must be found. Particularly in the case of electronic payments, where the real cost of making a transaction is extremely small, the mere fact that netting economizes on the number of transactions is unlikely to be a sufficient consideration. Thus, it is important to understand whether or not there is some additional benefit from using intermediated debt as a means of payment. The theoretical basis for such understanding is provided by Freeman (1996a, b), who shows that such a benefit does exist in some model environments.(2)

The use of cash settlement for the debt created in the payment system raises a further issue regarding the appropriate role of the public sector and especially of a central bank. Today, countries are taking various stands on this issue. In some countries, the government is solely a regulator of the payment system, while in others, the government is an active participant. In either case, there is a subordinate issue of how to apportion the responsibility for public-sector involvement among the treasury, the bank supervisory agency, and the central bank; and countries differ in their approach to this as well.(3)

Most current discussion of these issues considers the extent to which profit-maximizing operation of the payment system might potentially interfere with the conduct of monetary policy. There is consensus, although not unanimity, that this is not an urgent problem. However, there is another relevant issue that has not been much discussed: whether participation by the monetary authority can potentially enhance the economic efficiency of the payment system. …

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