Nova workboard

a blog from young economists at Nova SBE

(Ir)Rational Expectations and Cryptocurrencies: Next Step on Monetary Policy.

Investment Portfolios are getting flooded with cryptocurrencies and their behaviour is close to unforeseeable. Is the bitcoin a viable form of money? Should the Central Bank’s extend their price stability mandates to the crypto markets?

“… When you had what I wanted, or, I had what you were willing to take, a substance  which facilitated trade whose public and perpetual value, …coined by public authority, was created and called the price.” In ancient Rome, Julius Paulus Prudentissimus acknowledged that the true utility of a currency depends on its nominal properties. And so, currency efficiency relies on economic agents’ confidence on monetary system.

In 2009 (nearly 2 millennia later) a new transaction hub surfaced, Bitcoin. The first cryptocurrency, a decentralized, electronic cash system that facilitates digital transactions. Nowadays, there are over 1324 types of digital currency and this number is deemed to grow in the upcoming years. Dell, Microsoft or Tiger are already accepting bitcoin for online transactions and the simple act of acquiring a device has become attainable for someone with a wallet full of bitcoins.

Currency evaluation and Rational Expectations

While cryptocurrencies assert as a form of money, macroeconomic monetary theory starts to become under its scope. However, it is rather challenging to address such a volatile and unpredictable currency and several issues arise with its analysis.
On one hand, we are decomposing effects of a currency that, being decentralized, acts as an asset. Bitcoin is severely accompanied and essentially driven by risk perception and big market movements and capitalization. The real problem arises when one aims to measure that volatility, as the reasons for the risk faced by owning bitcoin is still unclear and so there’s no current volatility index accepted. Figure 1 depicts these volatility in the past few months, with variations of around 5000$ in two months.


On the other hand, the valuation of cryptocurrencies when compared to other fiat currencies. Are exchange rates between the dollar and the bitcoin trustable? Do they really reflect the true value of the digital money? It’s hard to tell. Stating that the Bitcoin or the Ethereum are overvalued when compared to the euro (current bitcoin valuation is 9518.97€) is not under scope as both are unalike. Cryptocurrencies allow owners to act under anonymity and are decentralized, these two facts cause the evaluation to be unrealistic (Scorer, 2017).

Then how do agents expectations adapt to uncertainty? In a Rational Expectations framework one should expect that for every “period”, agents would anticipate the value of the currency to be close to the past value subject to variations intrinsic to the models within which it behaves, as it is their best guess as educated agents. However, the foreseeable fraction of the cryptocurrency evaluation seems to be of null effect. Its volatility appears to be the main driver of its value, and so the agents cannot define their expectations in accordance as they do not know the sources of risk perception (they cannot evaluate the model properly). In fact, any guess regarding the true value of the Bitcoin is no more than that, an uninformed guess. A good illustration of this fact is the negative fluctuations that happen on value when there’s a day of bad advertisement for the bitcoin, “digital animal spirits” arise and agents are acting based on collective realizations.

Next Step: Innovative Monetary Design For Central Banks

Cryptocurrencies have been successful at getting rid of a centralized monetary authority, giving up the flexibility of an elastic supply of money. In fact, the Bitcoin supply is fixed at a certain level (calculated by an algorithm) to prevent malicious issuance of the currency.

Then, what is the range of monetary policy? In a world where digital payments have become increasingly popular – In Sweden and Denmark (Nicolaisen 2017) electronic payments have started to crowd out the use of cash – and where technology is allowing for more efficient construction of algorithms, a Central Bank Digital Currency (CBDC) is starting to be in the centre of the bullseye of economic research. Ethereum or Bitcoin are impossible to control by a rule or a specific mandate, as they are a private algorithm. However, a CBDC would ease the expectations and diversify the supply of money creating a variety of benefits (Bordo and Levin, 2017):

  • Costless medium of exchange. Additionally, the introduction of the CBCD would facilitate more rapid and secure settlement of cross-border financial transactions (He et al. 2017).
  • Risk-Free asset.
  • Base digital currency for private cryptocurrencies. Would create a trustable digital currency from which other cryptocurrencies, like Bitcoin or Bitcoin Cash, could be compared. For example, a spread between a CBDC volatility ratio and Bitcoin volatility ratio (assuming that one could be found over time) would give a good measure of risk for Bitcoin. Also, a comparison between the digital currency values could serve as a measure for undervaluation or overvaluation of a cryptocurrency.
  • Price Stability. Central Bank Digital Currency would give households and businesses confidence that a “basket of consumer items” would be stable over the medium and long run horizon acting as an easing of expectations. The relationship between agents and the central bank would be more transparent, promoting socially efficient allocations.

Under Rational Expectations, this natural extension of current trends in monetary operations would allow for a more efficient maximization of social welfare by the Central Bank. A risk free form of money joined with a secure price stability rule, would secure an alignment between agents expectations and the Central Bank actions. Furthermore, comes the control of pre-existing digital currencies, having a risk free comparable currency would provoke a more trustworthy valuation of other cryptocurrencies and less risk of an expectations crisis and in extreme cases, a bubble (Rogoff, 2016).


As digital currencies are treated as a mean of transaction and as technology development is increasing, it’s indispensable to reflect on the consequences of a wider use of cryptocurrencies in anticipation. Central Banks and monetary institutions cannot defy the risks of being passive on an issue like this. As big enterprises are accepting bitcoin for transactions, the risks of an uncontrolled currency become wider. In the years to come macroeconomists will surely undergo a broad discussion on the merits and downsides of the CBDC.

In the short term, this rational expectations crisis might not have a direct effect on the economy in a macro level. Nonetheless, in the long term where cryptocurrencies might be the most popular mean of transaction (due to its security and its digital properties), blurry expectations are a severe issue and so, government and monetary pressure is needed. Stiglitz (2017) affirms that this pressures will be the reason for the current expectations crisis to blow up, but if it is so, then the cryptocurrencies will avert to their true value over time. In a distant time horizon, this visible hand of the Central Bank Digital Currency, will be of utmost importance to limit agents’ expectations (through price stability) and give credibility and viability to a developing configuration of money.


  • Scorer, S (2017), “Central Bank Digital Currency: DLT or not DLT? That is the Question”, Bank Underground, 5 June.
  • Bordo, M and A Levin (2017), “Central Bank Digital Currency and the Future of Monetary Policy”, NBER Working Paper No. 23711.
  • He, D, R Leckow, V Haksar, T Mancini, N Jenkinson, M Kashima, T Khiaonarong, C Rochon, and H Tourpe (2017), “Fintech and Financial Services: Initial Considerations”, International Monetary Fund Staff Discussion Note 17/05.
  • Nicolaisen, J (2017), “What Should the Future Form of Our Money Be?” Speech at the Norwegian Academy of Science and Letters, 25 April.
  • Rogoff, K (2016), The Curse of Cash, Princeton, NJ: Princeton University Press.
  • CNN MONEY, “Nobel winner says bitcoin ‘ought to be outlawed’”, Ivana Kottasová, 1 December 2017

Bruno Carreiras, 22018.


Author: studentnovasbe

Master student in Nova Sbe

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