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Could Facebook's Libra Affect National Economies and Interest Rates?

Joseph E. Gagnon (PIIE) and Gonzalo Huertas (PIIE)



Facebook’s proposed “simple global currency,” known as Libra, has drawn skepticism, scrutiny, and debate since it was announced in 2019. European and US regulators are concerned about an American corporate behemoth harnessing blockchain cryptocurrency technology to dominate an important range of financial services. Nevertheless, on August 23, Bank of England governor Mark Carney delivered a speech that referred to Libra and highlighted some potential benefits of a coordinated move toward a global standard based on a basket of existing currencies, which he labeled a “synthetic hegemonic currency.” Concerns that Libra might replace national currencies and pose significant challenges for macroeconomic policymakers are overblown, however, at least in advanced economies.

Even if Libra gains traction, local currencies are likely to continue to be used for most transactions, with Libra limited to the most globally tradable goods and services. National central banks would retain the power to set domestic monetary conditions. There could be some impact on the average level of interest rates, however: Libra is backed by a basket of safe bonds and bank deposits, much like a mutual fund. As these are bought, interest rates in countries whose currencies are in the basket may decline. Interest rates in countries with currencies outside the basket may rise modestly.

As Martin Chorzempa discusses in a previous post, the basket of currencies is intended to give Libra coins a more stable value than bitcoin and other cryptocurrencies. Transactions using Libra could become cheaper and faster than conventional payments. The global reach of Facebook and other companies sponsoring Libra has led to predictions that it will be used extensively as payment for goods and services and to advertise or invoice prices. Libra could conceivably become an alternative to local currency bonds and bank deposits as an investment for households and firms.

But for advanced economies, which have sound monetary policy frameworks, salaries, rents, and local services will continue to be invoiced and paid for in national currency. Taxes, after all, need to be filed and paid in local currency, and government spending (a large share of GDP) is conducted in local currency too. The ability of even very small and open economies to avoid using the currencies of their neighbors reflects the sticking power of national currencies. With most prices and wages set in local currency, national central banks will continue to control the monetary conditions that matter for macroeconomic stabilization.

The Libra Association says that it does not plan to pay interest on Libra balances, making them less attractive as an investment. However, given the current low, and even negative, level of interest rates in many advanced economies, zero interest on Libra balances may not look so bad. Moreover, it is possible that Libra will pay interest in the future, making it fully competitive as a safe and liquid investment. By giving ordinary households a ready alternative to local currency deposits, Libra may increase the sensitivity of a country’s exchange rate to changes in its policy interest rate. But this effect would be relatively minor because firms and wealthier households, which control the bulk of all financial assets, already have easy access to foreign exchange.

The primary macroeconomic effect of Libra is likely to be on the level of interest rates and the market for sovereign debt. Widespread adoption of Libra would increase the demand for the securities that back Libra coins, pushing up their prices and reducing their rates of return. Economies with currencies in the Libra basket will experience upward pressure on exchange rates and downward pressure on interest rates. Conversely, economies with currencies outside the Libra basket will experience downward pressure on exchange rates and upward pressure on interest rates as their residents sell local assets for Libra tokens, thereby reducing overall demand for local assets.

These effects will depend critically on the choice of currencies and weights in the Libra Reserve basket as well as the size of the Libra Reserve, which in turn depends on the extent to which Libra is viewed as a safe and convenient investment, including in developing economies with a history of unstable and inflationary local currencies.

Some studies imply that holdings of US assets as foreign exchange reserves, which exceed $6 trillion, may have depressed US interest rates by several percentage points. However, the fact that US interest rates are among the highest in advanced economies, despite the massive holdings of dollars as reserve assets, suggests that cross-border investment in dollars has only a modest effect on US interest rates, probably less than one percentage point. It seems unlikely that Libra would move rates by more than a percentage point. Nevertheless, even modest downward pressure on interest rates in Japan and the euro area would be unwelcome as long as interest rates are below zero. In these economies, Libra may intensify the need for an enhanced role for fiscal policy in moderating economic downturns. Investing in assets with a negative rate of return could also make it harder for the Libra Association to meet its expenses.

Facebook announced that the Libra Reserve basket will “include the US dollar, the British pound, the euro, and the Japanese yen,” but no indication was given on whether other currencies are also being considered. It is surely no coincidence that these four currencies, along with the Chinese yuan, comprise the special drawing right (SDR) of the International Monetary Fund (IMF). IMF members (which include nearly every country in the world) have pledged to make the SDR the world’s premier reserve asset. Libra offers a chance to make good on this pledge. However, Facebook is not allowed to operate in China, which probably explains its reluctance to include the Chinese yuan in the basket.

If Libra is to become a widespread vehicle for international trade and investment, the composition of the Libra basket should be determined by the international community through an appropriate forum such as the IMF. The SDR basket is an obvious reference point. However, there is also a case to be made for a broader basket in order to spread the costs and benefits more widely and to make the global trading system more symmetric and less subject to the dominance of a single currency or small group of currencies. One way to reconcile these competing considerations is for Facebook to set the Libra basket equal to the SDR basket and for the IMF to broaden the SDR to include the currencies of all economies with sound monetary and fiscal policy frameworks, as discussed on page 28 of this symposium.

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