AMERICAS FEDERAL RESERVE recognized the disruptive potential of electronic money a long time ago. “This is a service that is expected to be used more and more as the user experience and economy are understood,” the New York arm said in a report. The year was 1917, and the Fed had just started giving banks the ability to wire funds without interest charges. Over a century later, central banks are struggling with another technological revolution: the rise of mobile payments and the move away from cash.
Just like at the beginning of the 20th century, when central banks created telegraph transmission networks, they now feel that they need to design their own digital payment networks to keep control of their currency systems. One idea that wins favor is the issue of a so-called digital central bank currency (CBDC) that would only exist as electrons on a computer chip and not as a coin or banknote. Around 80% of central banks do this CBDC Work, from research to studies, according to a survey. Although early on, this is a trend that could lead to new monetary policy opportunities.
Most central bankers were skeptical CBDCs initially, but in recent months, according to an analysis of her speeches by the Bank for International Settlements, her views have become more positive (TO), a club of central banks (see graphic). This is partly because they are now more familiar with the concept. China has already used the digital yuan to a limited extent on a trial basis, and Sweden is close to it with the e-crown. The corona virus pandemic has increased the urgency as more and more people shop online or pay with contactless cards or phones instead of cash.
The main motivation for spending a CBDC is probably defensive. The gradual decline of cash poses two basic risks. First, online payment systems could fail and suffer failures or hacks. To ensure the integrity of their currencies, central banks hope to offer fail-safe digital alternatives.
The second risk is that private-sector systems are too successful and more people are switching to payment platforms offered by large technology companies such as Facebook or Tencent. Many central banks took this risk seriously when Facebook launched its digital currency plans in 2019. As Hyun Song Shin, head of research at TOShifting to such currencies would be like shifting the economy from a market in the town square where all vendors are happy to accept cash to competition between full-service department stores. Once popular enough, department stores can stop you from shopping elsewhere and introduce new fees. Regulators might need private payment platforms for the connection, but a well-designed one CBDC would help ensure this by building a digital bridge between different systems.
European central bankers are most affected by the effects of a privately held digital currency on competition and consumer interest. The Fed seems to be further away from thinking about the idea, also because the Americans are making more money.
CBDCs also give central banks more control. They could make it easy to track transactions, which may make them more attractive to the Chinese authorities. In the west, where surveys show that the public cares more about privacy, CBDCs may need to ensure anonymity without bypassing anti-money laundering controls.
Where things are really interesting from a theoretical point of view is the impact on monetary policy. This is particularly the case when the new currencies are “retail”. CBDCS, made available to the public. (A less exciting option would be to issue “wholesale” CBDCs to commercial banks only, as they already receive funds from the central bank, although this is underpinned by better technology.)
CBDCs can facilitate the implementation of negative interest rates. Unlike old-fashioned cash, digital Fiat can be programmed. At the moment, interest rates cannot become too negative, as savers can always request cash that by definition offers zero interest rates. However, if digital cash were programmed to have a negative interest rate, people would have fewer setbacks and central banks would have more flexibility.
Central bankers could also be tempted by the possibility of targeted intervention – much to the dismay of those who are already concerned about the effectiveness of undelected monetary officials. Instead of lending to commercial banks, central banks could top up individual currency accounts. During a downturn, they could transfer funds to those with low balances. After a natural disaster, they could support the affected areas directly. And they could offer consumption discounts depending on how and where the money is spent.
However, these newly discovered forces would have disadvantages. For the CBDC To be a channel for negative interest rates, countries would likely have to have eliminated cash, otherwise people could still opt for physical instead of virtual money. In addition, if the CBDC has a deeply negative interest rate, people could lose confidence in it. Savers could request a different currency or asset, such as gold. With targeted interventions, there is a risk of programming too many special functions in digital currencies. They would start to resemble securities for specific purposes, undermining the fungibility that has been a feature of money since the days of cowrie shells.
Central banks would also have to watch out for new vulnerabilities. In the event of panic, savers could convert their bank deposits into theirs CBDC Accounts, which increases the burden on the financial system. Even without panic, strong demand for CBDCs could destroy banks’ deposit base, making them more dependent on wholesale finance, which is often more expensive and less stable. Some economists argue that withdrawal and emission restrictions could help avoid some of these effects.
In any case, the political consequences are initially a kind of money fiction. A more practical problem is whether central banks can build robust and user-friendly buildings CBDCs. There have been several examples of errors in public technology in recent months, from websites with overwhelmed unemployment in America to a discontinued corona virus tracking app in the UK. No government wants to see a currency crash, if only virtually. ■
This article appeared in the Finance & Economy section of the print edition under the heading “Bips and Bytes”.