Suppose I promise to be in the same place as you; but you make no promise to be in the same place as me. Then I am Beta follower and you are Alpha leader; because you go where you want to go and I must go to the same place to keep my promise.
We get the same Alpha-Beta relationship with asymmetrical fixed exchange rates. If the US Fed decided (for some unknown reason) to peg the exchange rate of the US dollar to the Canadian dollar, but the Bank of Canada makes no such promise the other way, then the US Fed becomes the Beta follower and the Bank of Canada becomes the Alpha leader. US monetary policy is now decided in Ottawa.
It's the same Alpha-Beta relationship between central bank and commercial banks. The Bank of Montreal pegs the exchange rate of the BMO dollar to the Bank of Canada dollar; but not vice versa. So the Bank of Montreal is Beta follower to the Bank of Canada's Alpha leader. The Bank of Canada decides Canadian monetary policy, not the Bank of Montreal.
Now let's add the Libra twist to this simple story.
Suppose I promise to be at a point midway between you and Alice; but you and Alice make no promises about where you will be relative to me. I am Beta follower. But Alpha leadership is now shared 50-50 between you and Alice.
If I understand it correctly (I quite possibly don't) Facebook's new Libra currency is supposed to be pegged to a basket of international currencies. Libra is then a Beta follower, just like a normal commercial bank. But unlike a normal commercial bank, which follows only one Alpha leader central bank, Libra will be following a basket of several central banks. So Alpha leadership is now shared (in proportion to those basket weights) between those central banks.
Which is an interesting twist.
My guess is that Libra will not take off into wide usage (JP Koning's good post explains why). But suppose it does take off, and replaces the money created by normal commercial banks which follow only one central bank each. What happens if the US Fed wants to loosen world monetary policy and the ECB wants to tighten? It's like you and Alice both running off in opposite directions, each trying to run faster than the other, to get me to follow in your direction rather than her direction and vice versa.
Update: it's like Libra creates the incentive for a Tug-of-War between the Fed and the ECB, with Libra tied to the middle of the rope. Except that it's not a rope but a very elastic rubber band.
This doesn't look like a stable equilibrium to me.
Nick - can elaborate on the scenario here?
Are we talking about a situation where most prices and contracts around the world are denominated in Libras and not local currency? In that case, seems right that each CB would only have some limited influence over prices in their own home economy. They would be in a slightly more powerful position than say the Italian CB was once the Euro was adopted.
But there is so much else to explore about a world in which this was true. Presumably, with so much economic activity being transacted in Libras, there would be an effect from the libra economy to the supply and demand of local currencies, which would end up dictating monetary policy to those banks!
Posted by: louis | June 27, 2019 at 01:22 PM
louis: yes, that's roughly what I have in mind. Libra becomes widely used as medium of exchange and unit of account.
Presumably the demand for central banks currencies would fall as a result of competition from Libra, and they would need to adjust the supply of their currencies to compensate for this. But that is exactly the same as the effect of normal commercial banking; normal commercial banks do not dictate monetary policy to central banks, because commercial banks peg to central banks, and not vice versa. What's new with Libra (if it takes off) is that central banks pool their alpha leadership role, and get into a Tug-of-War with each other in trying to pull Libra in opposite directions.
Posted by: Nick Rowe | June 27, 2019 at 03:29 PM
“The Bank of Montreal pegs the exchange rate of the BMO dollar to the Bank of Canada dollar; but not vice versa.” Strikes me that actually the BOM (or the Canadian government) does do some “pegging” in that it guarantees that BOM dollars will be exchanged at par with BOC dollars. That’s done via deposit insurance.
Next, I don’t see why the Fed and ECB changing their interest rates relative to each other is a problem for Libra: all Libra promises is that it’s currency units shall be equal in value to a basket of currencies. If the value of one of the latter currencies falls, that’s just tough for Libra holders.
Posted by: Ralph Musgrave | June 28, 2019 at 05:16 AM
Nick, why bother to label the leader "alpha" and the follower "beta"? I would have thought that you would have preferred to cut excess verbiage whenever possible.
Posted by: Frances Woolley | June 28, 2019 at 06:07 AM
Ralph: if the leader gave the follower an unconditional guarantee that the follower will not fall behind, then yes, the leader is no longer strictly the leader. But that guarantee comes with a clause -- that the follower will be wound up or taken over.
If the Fed and ECB run off in opposite directions as fast as they can, that's not a problem for Libra. But I think it's a problem for the Fed and ECB.
Frances: fair point. Because "Alpha and Beta" have become the names I have adopted for this particular approach of theorising who leads and who follows based on who pegs their exchange rate to whom.
Posted by: Nick Rowe | June 28, 2019 at 07:49 AM
Nick - "But that is exactly the same as the effect of normal commercial banking; normal commercial banks do not dictate monetary policy to central banks, because commercial banks peg to central banks, and not vice versa."
I've always nodded along to statements like that; the alpha and beta framework makes a lot of sense. But in this context, I'm starting to see the limitations of the framework. If Panama decides to peg to the US dollar, the Fed doesn't even need to notice and nothing that happens in Panama will influence Fed policy; however developments in the US economy will have ripple effects on Panama through effects on money and exchange rates. That's a true alpha-beta relationship. But although commercial banks promise convertibility into central bank money, and not vice versa, the central bank needs to pay a great deal of attention to what the commercial banks do... you could say the CB is constrained by commercial bank activity and follows them instead of vice versa, needing to offset what they are doing to expand or contract the supply of money.
Posted by: louis | June 28, 2019 at 01:29 PM
I agree.
One interesting thing that could change this is if Facebook started to modify the components of its basket. In which case it would become at least a bit more of an alpha. China does this with its RMB basket, and so does Singapore.
Posted by: JP Koning | June 28, 2019 at 02:04 PM
louis: fair point. Take an extreme case: suppose all the commercial banks closed down shop overnight. The central bank would have to take some big offsetting actions (depending on its target).
Posted by: Nick Rowe | June 28, 2019 at 02:05 PM
Nick - fair enough, but as you know, alpha and beta have other associations. Why go there?
Or, to put it another way - you've chosen to go there. Why?
Posted by: Frances Woolley | June 28, 2019 at 04:56 PM
Frances: some in the manosphere use "alpha beta". So do people testing new software. But the metaphor I want to evoke is the wolfpack. Because banks, like wolves, move around in packs. (Canadian banks are one pack, US banks a second pack.) And each pack has an alpha wolf (the central bank) that decides where the pack will go.
Bitcoin is a genuine lone wolf, in a pack all by itself. Libra is like a lone wolf, except it follows the average of all wolfpacks.
Posted by: Nick Rowe | June 29, 2019 at 08:14 AM
JP: sorry. Missed seeing your comment. Hmmm. In principle, by changing the weights in the basket continuously (though it might sometimes need negative weights), Libra could do whatever it likes, becoming a true alpha. Interesting.
Posted by: Nick Rowe | June 29, 2019 at 09:28 AM
This is the process for ethical Central Banking. You would want to align with currencies which have hard assets and R+D pertaining to neural Imaging, quantum geomapping, quantum structural monitoring, quantum or optical communications, and VTOL offensive capabilities using laser rail-gun or acoustic missiles. A century ago many existing public platforms for CB assistance were optimal; we should have promoted manned auto production supply chains. Trump is more hawkish about slowing down technology of a armer-based national industrial strategy than is the pro-tech EU.
Posted by: lateral Mimas | June 30, 2019 at 10:29 AM
In his article, JP Kooning hits the nail: you want to convert Bolivars into Libras bc bolivars are worthless. But why would FB buy bolivars? There is nothing to do with bolivars. Nobody buy bolivars precisely bc they are worthless, not the other way around. Gresham’s law still apply.
Once again , some tech geeks think they can reinvent the wheel but square bc they are utterly ignorant of 5k years of
history.
Being young is fun, but sometimes you need an old uncle to remind you to avoid the brown acid.
Posted by: Jacques René Giguère | June 30, 2019 at 06:41 PM