Abstract: The Role of the Fed in the Payments System: Historical and Comparative Perspectives
Paralleling debates in other network industries, economists and policy makers have questioned the extent of Federal Reserve intervention in the payments system, notably the Fed's operation of clearinghouses for check and electronic transactions. Those advocating deregulation or privatization point to comparative and historical evidence to demonstrate the viability of a more private system. Moreover, they argue that recent economic, political, and technological changes—namely, globalization, the information and communications technology revolution, and the deregulation of banking—have opened up potential markets for the private provision of payments services and so diminished the Fed's share. Through a historical and comparative analysis of payments systems in the United States and other G-10 countries, we identify those market segments where central bank intervention is nearly universal (for example, the settlement of large-value interbank transfers) and those where the Fed's role is distinctive (for example, the operation of check and automated clearinghouses). We then draw on the insights of network economics to explain the role of the Fed in the payments system, both the common and unique elements. Because of demand and liquidity externalities and the resulting potential market failures, some form of collective control and coordination is required to maintain an efficient, stable payments system; we show why these problems led to Fed intervention in the U.S. case as opposed to private solutions such as bank joint ventures. A critical factor driving state intervention in the U.S. payments system then and now is its more decentralized, fragmented banking system, a point clearly illustrated through a comparison with the Canadian case.