On their blog, Stephen Cecchetti and Kermit Schoenholtz voice doubts regarding the usefulness of universal central bank digital currency (U-CBDC). They argue:

… in an effort to retain their deposit base, commercial banks would surely raise the interest rate they offer to their customers relative to the rate on U-CBDC. … the introduction of U-CBDC would cause a substantial fraction of deposits to shift to the central bank, with the remainder prone to exit in a period of financial stress.

… if the Federal Reserve were to issue U-CBDC, we expect that this would not only hollow out the U.S. commercial banking system, but also destabilize the financial system in a range of countries.

… what would the central bank become? As its U-CBDC liabilities grow, its assets will need to expand as well. And, since commercial banking will have shrunk, so will the sources of private credit. At this point, the central bank turns into a commercial lender. It will become the state bank. In the allocation of funds, it will substitute increasingly for the discipline of private suppliers and markets, inviting political interference in the allocation of capital, slowing economic growth.

The problem with this argument is twofold: First, it disregards the possibility of liability substitution: Deposits may be replaced by other forms of bank debt. Second, bank balance sheet length is equated with lending capacity. But empirically, one is far from a perfect predictor of the other. For example, some countries rely much more heavily on bank credit than others, without obvious implications for intermediation and investment.

… we are compelled to ask what problem it is that U-CBDC is designed to solve. There seem to be three possibilities: the inability of monetary policymakers to set interest rates much below zero; the fact that paper currency is a vehicle for criminality; and the need to broaden financial access. On the first, we currently see little political support for interest rates that go meaningfully below zero. … As for criminal use of paper currency, as we argued in a recent post, there is a strong case for eliminating anything bigger than the equivalent of a U.S. 20-dollar note, but doing so does not imply a need for U-CBDC. Finally, there is financial access. Here, we see technology as providing solutions outside of the central bank [e.g., India’s program of providing costless, no-frills accounts].

Indeed, none of these arguments makes a convincing case for CBDC (especially since only the first one directly relates to the monetary system). But there are two more convincing arguments. First, it is preposterous to have governments prohibit citizens from using cash—the legal tender—for large transactions, and to force them into using privately issued money instead. Opening the central bank’s balance sheet to the public is a more liberal approach than restricting access to financial institutions.

Second, private money creation puts the central bank at a second mover disadvantage, effectively forcing it to serve as lender of last resort during liquidity crises or even as provider of bailout funds. Since the central bank is obliged to safeguard the payment system it cannot escape this disadvantage; regulatory measures—to the extent that they work and do not cause more harm—may alleviate moral hazard but cannot solve the time consistency problem completely. The more payments are conducted using CBDC the less can the banking sector and its customers dictate monetary policy.

To conclude, we see very little upside for central banks to issue retail digital currency. Instead, we see an enormous risk to the commercial banking system and political challenges for central banks. In the end, we wonder: would capitalism survive the introduction of U-CBDC? It may, but we are not at all sure.

As argued above, threats to capitalism also lurk in other corners.