E-Rupee to yield demand side learnings

Money issued by central banks has changed form over modern history from coins made with precious metals to paper money that could be converted on demand into gold, to inconvertible fiat money that is only backed by the word of a sovereign government.

The fourth big transformation is upon us. Central banks across the world have begun experimenting with various forms of digital money. India has also taken its first tentative step. The Reserve Bank of India (RBI) has launched two variants of a digital rupee on an experimental basis for wholesale transactions between banks and for retail transactions within the private sector.

A lot of the global discussion of digital currencies has been around the supply side, especially how central banks should design this new form of money. Less attention is paid to the demand side, even though traditional monetary economics itself gives equal weight to both.

There are lessons from recent history. For example, central banks were forced to abandon money-supply targeting as the intermediate goal of monetary policy because demand for money became unstable after the 1980s, as household and firms got a greater choice of financial instruments to hold. They shifted to interest rate targets. More recently, the value of Bitcoin swung wildly not because of instability of supply, but sudden changes in demand from users. Bitcoin was supposed to guarantee monetary stability by managing money supply through an algorithm rather than human agency; the demand side was given inadequate attention.