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The writer is a professor at Cornell University, a senior fellow at the Brookings Institution, and author of the book “The future of money“
With cash imminent, many central banks around the world are experimenting with – or in some cases rolling out – retail central bank digital currencies. Their time may have come and they have many advantages over cash, but CBDCs also pose threats to the very institutions that issue them.
Private digital payments are doing well in many countries, limiting the demand for central bank digital currencies. Central banks face the challenge of making the latter viable in retail and peer-to-peer payments but are not so successful that they completely replace private payments. Thus, the idea of digital currency coins as the digital equivalent of cash, which carries a zero interest rate and no special features, gives way to the possibility of programming digital money for specific purposes.
The possibilities are exciting. A recent white paper from the Monetary Authority of Singapore describes how these “purpose-linked funds” can be designed “to be used for their intended purposes, such as validity over a certain period, at specific retailers, and in pre-determined denominations.”
Taking out money with expiration dates may stimulate consumption. Government cash transfers in times of heightened uncertainty, such as Covid-19 stimulus payments, often go into savings, reducing their impact. These funds can be more precisely targeted, for example for the purchase of durable goods, which increases the economic power of remittances.
With cash gone, other options come into play as well: imposing negative nominal interest rates to discourage saving and boost demand in periods of severe economic distress. Programmable financial aspects can facilitate contractual arrangements, as funds are automatically released only when conditions are met by all contracting parties.
Such innovations open up new avenues for how money can improve the functioning of economies and societies. But it is worth considering the dark sides of any new technology.
Cash can be used anonymously and has a fixed value (in nominal terms, not in terms of the inflation rate) relative to the economy’s unit of account, which is usually a central bank-issued fiat currency. If units of central bank money having different characteristics are in circulation, secondary markets become conceivable for their circulation. People who would rather save than spend may willingly trade their “programmable” money at a discount.
Funds held in CIB’s digital wallets may be seen as more secure than those held in commercial bank deposits. After all, central banks never fail. The flight of money into CBDC wallets can destroy bank deposits and put central banks in an undesirable position to make credit allocation decisions.
These risks can be limited. New cryptographic tools could restrict the use of CBDCs by unverified people while allowing for privacy on low-value transactions. Determining the balances in the cryptocurrency wallets of the central bank’s cryptocurrency would reduce the risk of deposit flight from banks. Regulatory protection barriers may prevent central banks from being too closely associated with government operations.
However, innovations in the field of money still pose hidden dangers. Central banks can be considered political agents if their insight into payment transactions is used for purposes of law enforcement or surveillance. The “helicopter drops” of funds by the government into central bank digital currency digital wallets are financial operations but in the public mind may become associated with central banks, causing these institutions to be seen as tools of fiscal policy. In times of financial panic, CBDC digital wallet balance caps can be difficult to maintain, causing central banks to replace commercial banks as the main repository of the economy’s savings.
Even worse, authoritarian or even ostensibly philanthropic governments can see central bank money as a means to achieve their social goals. They can prohibit its use to purchase ammunition, illegal drugs, or pornography, or for services such as abortions.
Central banks already face threats to their independence, credibility, and legitimacy. The more money they issue, the more political pressure they will be exposed to. At a minimum, such innovations pose risks to the safety of central bank funds.
It would be a sad irony if the digitization of central bank money to maintain its relevance undermines the attributes that make it trustworthy. While central banks don’t have much choice, you may regret the day they set out to upgrade their retail funds.
