With pressures on their capital and new capital expensive where it is available, banks are likely to attempt to increase their margins and to slow down new lending, thereby reducing their capital requirements, for example by tightening non-price terms and conditions on new loans. One factor which regulators are watching carefully at present is the impact of the shift this month to the Basle II system of capital requirements for European banks. While Basle II improves on its predecessor and removes many undesirable incentives, it retains some procyclical features and any transition needs to be managed carefully. 8 The impact on expectations and confidence The other channel by which the financial market turbulence is likely to have macroeconomic effects is by prompting more cautious behaviour by households and firms. This might simply reflect uncertainty about the future. Firms may temporarily postpone investment because of greater uncertainty about the future path of demand. We saw an effect like this after 9/11 for example. But it might also reflect a revision by households and firms about the sustainable path of income and wealth in the coming years. The change in expectations may reflect the higher costs of borrowing and a higher risk of unemployment. Again a reduction in confidence about future growth may lead directly to lower consumption and investment. It is also likely to affect equity and property markets. Potential buyers may decide to wait before purchasing if they sense that there is a chance that prices may fall. Such behaviour can be self-fulfilling.
The market capitalization of digital assets reached $ trillion in November 2021.1 The rapid growth of digital assets presents opportunities to both reinforce the role of central banks and regulatory bodies in stewardship of the global financial system and be positioned at the technological frontier. However, this growth is not without risks: in May, the crash of Terra, an unbacked algorithmic stablecoin, and the subsequent wave of insolvencies, wiped out over $ billion of investor and consumer funds.2,3 Currently, the total cryptoasset market capitalization rests around $ trillion, a 66 percent decline from its November 2021 peak. When I consider the ways in which digital assets impact the mission of the Federal Reserve, I see several channels – including monetary policy and the provision of an elastic currency, the preservation of financial stability, and the smooth operation of the payments system. Regarding monetary policy and currency, in January, the Federal Reserve released a discussion paper that considers a future where digital assets may play a large role in our financial system, and in particular, establishes some broad principles and outlines some of the pros and cons of a central bank digital currency, or CBDC.4 While at present the Federal Reserve has neither issued a CBDC nor plans to do so imminently, ongoing research improves our understanding of the risks and opportunities inherent to a CBDC. Central bank money – a liability of the Federal Reserve – is the bedrock of the U.S. financial system.