Monetary Policy's Cryptocurrency Essay: A Challenge.

Discuss about the Monetary Policys Crytocurrency Challenge.

The supply of Bitcoin is limited by design based on algorithms that design how much of bitcoin is to be supplied. The supply of Bitcoin is capped at the level that it will be until 2040 and then shall remain the same “ad infinitum” . The supply curve increases at diminishing rate. Hence, the supply is inelastic beyond 2040 and slightly elastic before 2040. (G.Baur, Hong, & Lee, 2015)

The demand for bitcoin is the standard downward sloping demand and the demand for bitcoin decreases as price increases. However, Bitcoin, in itself has no intrinsic value and it’s price is largely governed by speculation, it is difficult to understand the path that bitcoin will take in the future. Hence, the elasticity is unpredictable.

Figure 1 Demand and supply of Bitcoin. Source: Prepared by Author

(G.Baur, Hong, & Lee, 2015)

The increase in price was caused due a sudden surge in the demand for Bitcion. Bitcoin can be seen as an asset that is subject to speculation. As the speculation surrounding bitcoin increased, the demand for bitcoin increased causing a increase in the demand for bitcoin. The supply of Bitcion is scarce by design. In it controlled by algorithms. As a result of the interaction of the supply and demand forces of Bitcoin, the price of Bitcoin has increased.

In the diagram below, the original demand for bitcoin is depicted as DD1. As the demand for bitcoin increased, the demand curve shifted towards the right while the supply remained constant.

The price for Bitcoin Increased from P_o to P₁

Figure 2 The demand and Supply of Bitcoin : Shift in Demand Curve

Source: Adapted from (Mankiw G. , 2008)

Some of the factors that led to the shift in the demand curve to the right are: (Cameron & Trinh, 2017)

• Increased Coverage: The increase in the positive coverage by the media leads to a higher interest. This is typical of new technology which go through a hype cycle of media coverage where there is there is peak interest about a technology in the beginning.
• Bitcoin is also, an ideal investment for those who wish to hedge against volatility in currency, given a dynamic political environment. In the last few years, the world has experienced plenty of political and economic upheaval such as the debt rises in Europe, the national election of USA in 2016 and more. These crises add to global uncertainty and a currency like bitcoin, that is not backed by countries could seem like an effective hedge.

Money Supply is one of the most important levers of the economy that affects investment, wages , prices and all key aspects of economy. Monetary policy relies on the control of movement of ‘broad money’, through various policy tools such as bank reserve ratios, interest rates, open market operations for purchase and sales of treasury bills and currency exchange rate manipulation. (Mankiw G. , 2008) (Rajyadhaksha, 2018)

This stems from the belief that inflation in itself, is a monetary phenomenon and the impact of monetary polices is predictable only if the demand for money is predictable. If the demand is predictable, then Central Banks can look towards adjusting the money supply in the same measure. (Mankiw N. G., 2009)

Demand and supply of Bitcoin

If cryptocurrencies become a common medium of exchange, then citizens can use the money they own , instead of promissory notes and the coins distributed by the Central Banks, which are not owned by them. In very simplistic terms, the prevalent blockchain technology (the technology underlying bitcoin) can help citizens can access base money for use from the central bank itself. In theory this means that the money will be deducted from and added to the balance sheet of the Central Bank and the Central Bank can directly become a banker to citizens, instead of being a banker to the banks. Thus, the formulation of any monetary policy maker will be based on precise information regarding the demand for money. This information may even be real time. (Rajyadhaksha, 2018)

The Reserve Bank of Australia relies heavily on the implementation of monetary policies to control the drivers of GDP such as inflation, wages etc. On one hand, inflation targetting may becomes easier, if the above mentioned changes come into effect (Mankiw N. G., 2009). On the other hand, implementation of monetary policy through interest rate increases and decreases may become slightly more difficult due to presence of a medium of exchange that is not backed by gold or any other similar mechanism. This will affect the overall GDP of the country. (Rajyadhaksha, 2018)

It is possible that access to another medium of exchange may have an inflationary effect on the GDP of the country. On the other hand, the availability of another liquid or semi-liquid asset may induce consumers to invest more and have fewer liquid balances in hand. The effect that Cyrpto currencies might have on currency circulation is not known yet. Hence, it is difficult to predict the effect that they may have on the GDP. This raises several questions regarding the governance of Cryptocurrencies.

The Demand Curve for the Wine represents the price that the consumers will pay for every case of wine. The Demand Curve is usually based on the underlying expectation of private benefit that consumers believe they will enjoy. (Mankiw, 2008)

Consumer surplus is achieved whenever the price paid by any consumer is less than the price that they were willing to pay. An imposition of  tariffs raises the price of the product for the consumer. As a result, the price may increase above the Willingness to Pay for the consumer. Hence, the consumer does not have any surplus . This can also be interpreted in a different way. If the tariff on Australian wine increases the prices of Australian, wine, Canadian wine will have lower competition. Hence, Canadian wine makers will not have an incentive to reduce prices. If the current prices are lower than the consumer’s Willing ness to Pay, then the consumer has a surplus. (Mankiw, 2008)  Consumer surplus is the Marginal Private Benefit that any consumer enjoys over and above the benefit that was paid for.

Factors that led to the shift in the demand curve

PFT is the price per case of wine without tariffs. At this price the import demand for Australian wine in Canada equals the export demand from Canada for wine in Australia.

The line BCD is the quantity traded. Tariffs imposed by Canada will cause a rise in the price of Australian wine in the domestic market of Canada). In the diagram, price is increased from Po to P1 and the price in the domestic market of Canada increases to that extent.

Figure 3 Effect of a Tariff on the Price of Australian Wine; Consumer, Surplus , Producer Surplus, and Deadweight Loss

 The Demand Curve for the Wine represents the price that the consumers are prepared to pay for a hypothetical quantity of a good, based on their expectation of private benefit. (Mankiw, 2008) This price is known as the willingness to pay price. This is represented as WTP in the above diagram.

Producer surplus is the marginal private benefit that producers may receive,  (usually expressed in terms of profit) when the price received per quantity of the good due to the market mechanism is greater than the minimum price that they were willing to supply. This is represented as Seller’s price or Ps in the above diagram. Producer Surplus is the reward received by producers when the price is greatly in excess of their their costs of production. (Mankiw, 2008)

Deadweight Loss is the total loss of the market surplus (consumer and producer surplus) that may be brought about due to a distortion in the market i.e. when the market is not allowed to function according to market sources. Taxes and subsidies cause distortions in the markets. The effects of deadweight loss is calculated as the difference between the net consumer and producer surpluses and the net consumer and producer losses. For example, a tax on wine may decrease producer surplus by increasing their cost of production. If the producers pass on this increase in cost to consumers and the price increases above the willingness to pay of the consumer, then there is a loss in consumer private benefit too. The total result is calculated as the deadweight loss. (Chauhan, 2015)

Ps is the price per case of wine without tariffs. At this price the import demand for Australian wine in Canada equals the export demand from Canada for wine in Australia.

The line Q1 is the quantity traded. Tariffs imposed by Canada will cause a rise in the price of Australian wine in the domestic market of Canada). In the diagram,  price is increased from Po to P1 and the price in the domestic market of Canada increases to that extent.

Impact of cryptocurrencies on monetary policies

2.2  Ps is seller’s price and the price per case of wine without subsidies. Subsidies will bring down the price for Canadian wine in Canada to Pb. At this price, the producer experiences a producer surplus while consumers also experience a consumer surplus due to the lower price.

Figure 4 Effect of a subsidy on the Price of Canadian Wine; Consumer, Surplus , Producer Surplus, and Deadweight Loss

The result, however, not shown here, is the impact on Australian Wine Makers who will experience a producers’ loss due to the lowered demand.

2.3  The exports of Australian Wine to Canada were values as USD 183 million for the year 2016-2017 (Department of Foreign Affairs and Trade, Australian Government, 2018).  The Canada Australia Free Trade Agreement is one of the few Free Trade Agreements that is in effect can be used to negotiate lower tariffs from Canada with Australia. Other non-tariff barriers may also be negotiated with Canada. These may help lower the prices for Australian Wine  exports to Canada. However, according to this agreement, Australia will also have to reciprocate with lower tariff and non –tariff barriers, in order to gain substantial gains for the Australian wine in Canada. (Department of Home Affairs, Australian Government, 2018)

The new version of the Trans- Atlantic Partnership, the ‘Comprehensive and Progressive Agreement for Trans-Pacific Partnership’ or the TPP-11 has been signed but not yet in effect. This is potentially another Free trade Agreement that could be useful is negotiating greater market access for Australian Wine in Canada.  According to this Agreement, Australia has negotiated a 98% reduction is tariffs for the market in Canada for various goods. Wine is one of the key goods that has been especially considered for a reduction. According to Department of Foreign Affairs and Trade, Australian Government, 2018,  wine exported from Australia to Canada is subject to “Elimination of Canada's tariffs (currently 1.87 ¢/litre and 4.68 ¢/litre) upon entry into force of the TPP-11.”

2.1 The Efficiency of Wages explains how wages are determined and how the productivity of labour is increased due to a increase in the wages may  increase productivity Efficiency wages have , often, been used to explain the downward effect of wages in markets as well as to explain why unemployment persists. (Georgiadis, 2012)

The main statement of the Efficiency of Wages Theory is paradoxical in nature . The theory on one hand provides a case for greater efficiency of labour while, at the same time is one step away from the efficiency of the market mechanism that determines wages through the demand and supply forces. The main statement of the theory is that “The efficiency wage is the wage above equilibrium that firms voluntarily pay to increase productivity and profits.” (Weiss, 1990) Essentially, the theory states that wages do not only determine the total labour employment but also the “productive behavior” of the employee and quality of work. Hence, employees are better off paying wages that are not simply determined by the market forces but wages that will motivate workers to be provide greater productivity and quality. (Georgiadis, 2012)

Reserve Bank of Australia's dependence on monetary policies

Thus, the provides a case for the application of minimum wage floors. Workers may work for the minimum wages set by demand and supply forces. However, that mechanism does not take into consideration the quality and productivity of work. It is simply a quantitative analysis. (Weiss, 1990)

A combination of quantitative and qualitative analysis can be mathematically determined as follows: (Gupta, 2009)

Marginal Productivity of Labour X Total Number of Labour Employed =  Output

• The Marginal Productivity of Labour is the average amount of the units of a good produced by every additional labour employed.
• The Total Number of Labour Employed is the total number of labourers employed at the manufacturing unit.
• Output is the total number of units produced

In this equation, the total output could be optimized by optimizing, both the productivity of labour and the total number of labourers employed.  According to the Theory of Efficient Wages, the productivity of labour can be increased by increasing wages. Hence, the optimal combination of the total number of workers in an industry or economy and productivity can be useful in determining the minimum wages.

3.2Minimum Wages can be a Double Edged Sword. The implementation of minimum wages policies can have both, positive as well as negative effects.

The advantages of Minimum Wages are that minimum wages provide a minimum amount of income to a labourers so that a labourer can focus on improving the quality of work, instead of focusing increasing the number of hours worked in order to earn more income, according to the Theory of Efficiency of Wages. (Weiss, 1990)

Minimum Wages go against the market mechanism and may result in producer losses. This results in the sacrifice in the overall efficiency of the market. Under the regulations of minimum wage, the wages are not set by the market demand and supply but other resources. As a result, there can be unemployment. This is especially true of industries or professions where tertiary or secondary education is not requires and most of the workers are low wage, unskilled or semi skilled workers. (Georgiadis, 2012)

This problem will be further complicated in the future due to the emergence of a robot economy. It is expected that the emergence of robotic technologies such as 3D printing, Artificial Intelligence, Robotics to name a few that will replace the human labourers who are employed in jobs where basic and unskilled or semi skilled tasks are to be completed. (Borland & Coelli, 2017)

However, this, prediction in itself presents a case of minimum wage. If workers are offered payments higher than minimum wage, then workers could take initiatives or would be willing to take training to indulge in activities that would improve the levels of their skills. (Gupta, 2009)

Effect of tariffs on consumer and producer surplus

The Following Recommendations are provided for any new business looking forward to doing business in Australia

Planning for Economies of Scale: Minimum Wage implementation, implied minimum costs. Hence, a minimum threshold of scale should be identified where the optimal economies of scale would kick in. Planning for economies of scale in a way that it lowers the marginal costs of labour will ensure that the costs of labour are earned. (Mankiw, 2008)

Investment in Skills of Workers: If a firm is able to pay the labour according to the  Marginal Productivity of Labour, there would be no unemployment. (Gupta, 2009) However, since firms are required to pay minimum wages, they require a high level of productivity from a worker.

Planning for an Automated Future: It is in the interest of the firm as well as labourers that the firm undertake activities and investments that continually upgrade the skills of the workers. This should hopefully, increase the productivity of workers. In the longer term, robotics and other similar technologies could be used to substitute human labourers in the marginal jobs. (Borland & Coelli, 2017) However, a greater workforce would be required to supervise these specialized technologies. Hence, in the longer run, the firm may benefit in training employees for these specialized jobs.

Borland, J., & Coelli, M. (2017). Are Robots Taking Our Jobs? Australian Economic Review, 377-397.

Cameron, A., & Trinh, K. (2017, November 17). Four factors driving the price of Bitcoin. Retrieved from The Conversation: https://theconversation.com/four-factors-driving-the-price-of-bitcoin-87244

Department of Foreign Affairs and Trade, Australian Government. (2018, March 7). TPP-11 Outcomes: Goods market access. Retrieved from Australian Government, Department of Foreign Affairs and Trade: https://dfat.gov.au/trade/agreements/not-yet-in-force/tpp-11/outcomes-documents/Pages/tpp-11-outcomes-goods-market-access.aspx

Department of Home Affairs, Australian Government. (2018). Free trade agreements. Retrieved from Australian Government, Department of Home Affairs: https://www.homeaffairs.gov.au/busi/free/cana

G.Baur, D., Hong, K., & Lee, A. D. (2015, November). Bitcoin: Currency or Asset? Retrieved from The University of MElbourne: https://mbs.edu/getattachment/fircg/FIRCG-2016/Papers/8-Adrian-2c-KiHoonBitcoin-Baur-et-al-2015-P.pdf.

Georgiadis, A. (2012, December). Efficiency Wages and the Economic Effects of the Minimum Wage:Evidence from a Low-Wage Labour Market. Oxford Bulletin of Economics and Statistics, 962-979. Retrieved from https://pdfs.semanticscholar.org/27ca/f021788ea3b20d3f8a19fa655bc7a82bddb6.pdf

Gupta, K. R. (2009). Advanced Microeconomics: 2 Edition 1. New Delhi: Atlantic Publishers and Distributors.

Mankiw, G. (2008). Principles of Microeconomics (5th ed.). Mason Ohio: Cengage Learning.

Mankiw, N. G. (2009). Study Guide, Brief Principles of Macroeconomics, Third Edition. Canberra: Cengage Learning.

Rajyadhaksha, N. (2018). Monetary policy’s crytocurrency challenge. Retrieved from Live Mint: https://www.livemint.com/Opinion/49fqM520KSoQR2OvkfnVNI/Monetary-policys-cryptocurrency-challenge.html

Weiss, A. (1990). Efficiency Wages: Models of Unemployment, Layoffs, and Wage Dispersion. Princeton, USA: Princeton University Press.