Source: Bank for International Settlements
It is a great pleasure for me to join you today. Many thanks to the staff at the Federal Reserve Bank of Philadelphia for the invitation. 1
BIS Innovation Hub
Today I want to talk about change and central banks. But before I begin, allow me to briefly introduce the BIS Innovation Hub. The Bank for International Settlements supports central banks in their pursuit of monetary and financial stability by fostering international cooperation. The Innovation Hub was created five years ago and can be described as a joint venture between the BIS and the central banks who host our seven centres. The Innovation Hub has almost 100 people working together across the world. Our mandate is to follow and explore new technology and, when suitable, develop public goods. And to do that we research technologies and challenges that matter to central banks by building proofs of concept or prototypes. In more than 30 projects to date, we have collaborated with central banks and other partners to demonstrate the art of the possible. Currently, tokenisation and artificial intelligence are important areas for us, where we have multiple projects under way. Another crucial area is ensuring the integrity and safety in the financial system by exploring possible improvements to services like payments. Again, we aim to demonstrate the art of the possible. Adopting some of the technologies or implementing the outcomes of our projects is not up to us. Ultimately, countries’ authorities decide what becomes reality in their jurisdictions.
So why am I here? Well, when I was asked to join you here at the Philadelphia Fed, I immediately said yes. Maybe too fast, because the organisers kept asking me what I wanted to announce. I had to disappoint them. This is not a public service announcement. I am not trying to sell you anything. What I want to do in the next 10 minutes is explain why central banks care about change and innovation – and why that matters to us all.
Technology and change
Let me start with innovation and change, for which I will look to Adam Smith. Who better? The Wealth of Nations was published about 250 years ago. And Adam Smith uses the example of moving goods by road or by ship. Canal companies were the big techs of the day. They could move things faster and cheaper, and only the most niche products chose the horse and cart. Yet 100 years later, the transport network and – by extension the industrial capacity of Britain – was totally unrecognisable.
What changed? In that time, railways happened. Or more accurately, innovation changed how railways were used. There were railways when Adam Smith was writing. But they were small, private and horse-drawn. He did not even mention them as a contender to roads and ships. But 50 years of innovation in steam engines – to make them smaller, faster and more efficient – would make railways far superior to canals. Following some smaller private railways, the first public railway – from Liverpool to Manchester – opened in 1830. At that time, there were about 125 miles of railways in England. Over the next 40 years, this grew to 13,000 miles. Canals were dead in the water.
Was the change smooth, clearly predictable and always rational and obvious? No. Was it just the technology advantages that catalysed the change? No. It was many things. Financial innovations meant that investments in railways were easier. Yet this also created a financial bubble. Early safety regulations reassured a sceptical public – but not before some terrible accidents. Competition drove further innovation but resulted in a grossly inefficient network. When agreement on a standardised width of railway gauge was eventually brokered, network effects could be enhanced. The standard adopted was George Stephenson’s 4 feet, 8 1⁄2 inches, which spread across England and internationally. I have been told the United States uses it too.
But why am I telling you a story about something that happened in England hundreds of years ago? Well first, I enjoy history. But second, because it is a great example of how technologies change. Do you see any parallels with today? Railways did not just “win” overnight. They were initially less efficient than canals. Canal owners saw the threat and organised resistance. Yet railways improved faster than canals could – at least once steam engines became technologically and commercially viable. Investment played a significant role in this. So, at times, did safety regulations and politics. There were battles about which standards should be used. And importantly, change driven by technology and innovation is not an elegant dance. It is a race and a tussle and sometimes a mess.
To really make the point, allow me one more historical example closer to home. The Federal Reserve Bank of New York recently published an article about when securities markets scrapped paper in the 1960s and ’70s. At that time, IBM and Honeywell were in a race to develop more powerful computers. And stockbrokers were racing one another to use them for competitive advantage. The winners of that race went on to dominate securities markets for decades because they bought out the failing houses that could not operate their computers as effectively. And the digital infrastructures they created, based on the paper processes before them, are the ones we use now. And they are the same infrastructures now experimenting with tokenisation and are maybe on the cusp of another change.
Understanding change
How do industries and society manage these huge changes? Almost all industries have regulations of various kinds to ensure safety, competition and transparency – standards with a large or small “s” that are adhered to. Yet finance has something that planes, trains and automobiles do not. Finance has central banks. And why do they care about innovation and change?
First, for monetary analysis. For central banks to set interest rates to stabilise prices they have to understand the economy. The data collection and analysis of credit, demand, output, supply, costs, prices and labour markets all roll up to into determining monetary policy. And innovation can have a huge impact. AI is an obvious example. But digitalisation more broadly has had and will continue to have a fundamental impact on the global economy. For effective policymaking, central banks need to understand where things are heading. So they must follow and explore innovation and its implications.
Second, central banks care about innovation because of their oversight role. For prudential supervision of banks and market infrastructure, it is necessary to understand how technology is being used and the effect of any large changes. Financial stability analyses are increasingly concerned with how financial and operational risks interact. Technology is a significant variable in that analysis.
Third, central banks do not just think; within their mandate, they act. To deliver on their monetary policy objectives, they decide where interest rates need to be. And then they act through their market operations to make that happen. Central banks want safe settlement and so they offer it – by operating payment systems to safely and reliably move substantial amounts of money every day. And they provide banknotes.
It is because central banks act that they are really part of any change – not on the sidelines or just observing, but really involved. As part of the financial ecosystem, central banks offer settlement in central bank money, which is the safest settlement asset possible and a pillar of a stable and robust financial system. And this is what makes them so different from a regulator in any other space. To put it very simply, if central banks think technology is changing, they need to consider and adapt as well. And they need to change operations and systems that require the highest possible resilience from cyber threats and operational risk. That puts a very different slant on any decision and perhaps adds some caution. It might also add some practicality. And importantly for an economist, it gives central banks skin in the technology game – and the right incentives.
Incentives matter. Trust in money is grounded on two things. The first is the central bank’s monetary policy framework and operational independence. The second is the competence to carry out its role. And that competence increasingly means the ability to use technology better. To do that we experiment. We collaborate. We get involved. But our role is not to win or to profit or to tell the private sector how to run their business. The private sector will always know what customers need and want better than the public sector. But it is also important to have the public sector involved, with public policy objectives such as stability, safety, interoperability and compliance.
BIS and international cooperation
To close I want to talk about how these themes of technology, change and incentives play out internationally. Central banks are different from one another. But I have spoken for almost 10 minutes about their interests and incentives as a homogeneous group. And if I can do that, they must be similar enough to cooperate.
The BIS’s job is to help and guide central bank cooperation. Given what I have said, that should be easy. But collaboration is not always simple. Yet, with the right governance and communications, building knowledge by running projects together could reap great rewards for central banks.
Our projects are “just” a first look at what is possible. Projects are not a commitment. Some of the questions like whether there is a need for central bank digital currency or digital identity can only be answered politically. The central bank is one of many advisers on a decision that should be made with other players in our societies. That is right and that is normal. Yet the fact remains, for good policymaking on any subject, you need understanding. And with technology, you need to experiment and collaborate to obtain that understanding.
So, I thank you again for the invitation and attention. I will close with a quote from Adam Smith: “I have never known much good done, by those who affected to trade for the public good.” Eerily, he foresaw a version of what US president Ronald Reagan famously highlighted as the nine most terrifying words: “I’m from the government and I’m here to help.” The BIS Innovation Hub has a mandate to explore technology and to develop public goods. But others ultimately decide what could be changed. Our job is to learn and advise them so that when change happens, it can happen for the better.
Thank you for listening.