Abstract: I offer a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public use electronic central bank money. After distinguishing RFA from cryptocurrencies and relating the proposal to discussions about narrow banking and the abolition of cash I propose an equivalence result according to which a marginal substitution of outside for inside money does not affect macroeconomic outcomes. I identify key conditions on bank and government (central bank) incentives for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate my analysis to common arguments in the discussion about RFA and point to inconsistencies and open questions.
VoxEU, August 20, 2018. HTML.
- To a first approximation, inside and outside money are substitutes—the introduction of CBDC does not change the equilibrium allocation.
- Bank incentives and central bank incentives might be affected though.
- CBDC could increase the incentive to extend credit but might undermine the political support for implicit financial assistance to banks.
I offer a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public use electronic central bank money. After distinguishing RFA from cryptocurrencies and relating the proposal to discussions about narrow banking and the abolition of cash I propose an equivalence result according to which a marginal substitution of outside for inside money does not affect macroeconomic outcomes. I identify key conditions on bank and government (central bank) incentives for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate my analysis to common arguments in the discussion about RFA and point to inconsistencies and open questions.
Radio Bern RaBe, May 15, 2018. HTML with link to podcast (interview starts at 08:15).
- Interview with Radio Bern RaBe about Vollgeld and the Vollgeld initiative.
According to RenNZZ.Scheu in the
Die zehn «Massregeln» für die «fortgeschrittensten Länder», in die das «Kommunistische Manifest» mündet, lesen sich aus heutiger Sicht wie ein sozialdemokratisches Programm, dem auch viele softbürgerliche Politiker sogleich vorbehaltlos zustimmen würden. Starke Progressivsteuer, Geldmonopol der Nationalbank, Zentralisation des Transportwesens, nationale Industriepolitik, Verstaatlichung des Bauernstandes und unentgeltliche Erziehung aller Kinder gehören längst zu den Errungenschaften avancierter Wohlfahrtsstaaten – damit sind wohlgemerkt bereits sechs der zehn Punkte erfüllt….
Marxens Kritik zielt nicht auf den Unternehmer und Eigentümer als solchen, sondern auf den Bourgeois, der auf der faulen Haut liegt und auf Kosten anderer lebt. …
Der Verfasser des «Manifests» ist kein Moralist, sondern ein geradezu passionierter Ökonomist der ersten Stunde.
And according to The Economist:
- Modern “capitalism” often reduces to rent seeking: The Economist mentions “corporate bureaucrats”, “management consultants”, “professional board members”, “retired politicians (who spend their twilight years sponging off firms they once regulated)”.
- It is global (WEF).
- It has a tendency towards monopoly (Google, Facebook, …).
- It yields an army of casual workers (gig economy).
- But Marx overestimated poverty and underestimated reform.
Isaiah Berlin: Karl Marx and his Environment.
SRF, April 28, 2018. HTML with link to audio file (interview starts at 13:15).
- Interview with Swiss public radio about Vollgeld and the Vollgeld initiative.
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.
Central bankers often argue that CBDC would increase the risk of bank runs. On his blog, JP Koning rejects this notion. After all, he retorts, during a confidence crisis bank customers would no longer have to queue to withdraw cash; lender of last resort support would be provided much more quickly; and “large” cash holders would continue to shift funds into treasury bills, not into CBDC.
The general criticism here is that during a crisis, households and businesses will desperately shift their deposits into the ultimate risk-free asset: central bank money. Presumably when deposits were only redeemable in banknotes (as is currently the case) and one had to trudge to an ATM to get them, this afforded people time for sober contemplation, thus rendering runs less damaging. But if small depositors can withdraw money from their accounts while in their pajamas, this makes banks more susceptible to sudden shifts in sentiment, goes the Carney critique.
I don’t buy it. … even in jurisdictions without deposit insurance, I still don’t think that shifts into digital currency in times of stress would exceed shifts into banknotes. A bank will quickly run out of banknotes during a panic as it meets client redemption requests, and will have to make arrangements with the central bank to get more cash. Thanks to the logistics of shipping cash, refilling the ATMs and tellers will take time. In the meantime a highly visible lineup will grow in front of the bank, exacerbating the original panic. Now imagine a world with digital currency. In the event of a panic, customer redemption requests will be instantaneously granted by the bank facing the run. But that same speed also works in favor of the bank, since a request to the central bank for a top-up of digital currency could be filled in just a few seconds. Since all depositors gets what they want when they want, no lineups are created. And so the viral nature of the panic is reduced.
But what about large depositors like corporations and the rich … ? During a crisis, won’t these sophisticated actors be more likely to pull uninsured funds from a bank, which have a small possibility of failure, and put them into risk-free central bank digital currency?
I disagree. In a traditional economy where banknotes circulate, CFOs and the rich don’t generally flee into paper money during a crisis, but into short-term t-bills. Paper money and t-bills are government-issued and thus have the same risk profile, t-bills having the advantage of paying positive interest whereas banknotes are barren. The rush out of deposits into t-bills is a digital one, since it only requires a few clicks of the button to effect. Likewise, in an economy where digital currency circulates, CFOs are unlikely to convert deposits into barren digital currency during stress, but will shift into t-bills. The upshot is that banks are not more susceptible to large deposit shifts thanks to the introduction of digital currency—they always were susceptible to digital bank runs thanks to the presence of short-term government debt.
Of course, depending on the type of CBDC, central banks might also choose to pay negative interest on CBDC in order to depress demand for it.
The Journal of Economic Dynamics and Control has published a special issue with the papers of the conference on “Fiscal and Monetary Policies” that the Study Center Gerzensee co-organized with the JEDC, the St. Louis Fed, the University of Bern, and the Swiss National Bank.
This earlier post contains a link to the conference program.
Jointly with the Journal of Economic Dynamics and Control, the St. Louis Fed, the University of Bern and the Swiss National Bank, the Study Center Gerzensee organized a conference on Fiscal and Monetary Policies. The program can be viewed here.
On Alphaville, Izabella Kaminska asks why a central bank would want to issue cryptocurrency rather than conventional digital currency.
… if anonymity is not the objective of issuing a centrally supervised cryptocurrency, what really is the point of using blockchain or crypto technology? Just issue a conventional digital currency and be done with it. If, on the other hand, anonymity is the objective of issuing a centrally supervised cryptocurrency, how can this be justified by a central bank in light of years of regulatory policy focused on making sure cashflows are more easily tracked and monitored … The idea it should be the central bank unwinding this trend is utterly bizarre.
… the only incentive central banks really have for introducing cryptocurrencies is in performing a giant monetary bait and switch. “Hey guys! We’re offering this amazing anonymous central bank currency which is as strong and stable as the dollar and yet just as anonymous as bitcoin!!! Come, all you illicit users of physical cash, come use our amazing new currency! We swear it’s absolutely anonymous and will never lead to prosecutions. Honest!!”
Her post relates to a recent BIS Quarterly Review article by Morten Bech and Rodney Garratt.
- The Vollgeld initiative may point to a problem but it does not propose a viable solution.
- Even with Vollgeld, the time consistency friction with its Too-Big-To-Fail implication would persist.
- A more flexible, liberal approach appears more promising.
- It would give the general public a choice between holding deposits and reserves.
- Financial institutions and central banks around the world are pushing in that direction.
In the FT, Martin Arnold reports about a new cross-border payment method tested by the Bank of England. The “interledger” program transfers money “near-instantaneously and without settlement risk.” The Bank of England
set up two simulated RTGS systems on a cloud computing platform, using the Ripple interledger to simultaneously process “a successful cross-border payment”.
This is not necessarily good news for the blockchain community. The Bank of England’s proof of concept is
“about connectivity between central bank systems rather than replacing the central bank systems with the blockchain,” [according to] Daniel Aranda, head of Europe at Ripple.
In: Thomas Moser, Carlos Lenz, Marcel Savioz and Dirk Niepelt, editorial committee, Monetary Economic Issues Today, Festschrift in Honour of Ernst Baltensperger, Swiss National Bank/Orell Füssli, Zürich, June 2017. PDF of draft.
The sovereign money initiative (Vollgeldinitiative) seeks to gain greater control over the money and credit supply, to increase financial stability and to achieve a fairer distribution of seigniorage income. The initiative’s suggested approach – a ban on active money creation – is inefficient and may even prove ineffective, as it fails to address the core problems. A variant of the initiative, which would allow the public access to electronic central bank money on a voluntary basis, would offer greater benefit at lower cost.
In an ECB occasional paper, Ulrich Bindseil, Marco Corsi, Benjamin Sahel, and Ad Visser review the European Central Banks’s collateral framework.
From the executive summary, on misconceptions:
… differences e.g. with interbank repo markets: first, central banks are not subject to liquidity risk in the way “normal” market participants are, and can therefore accept less liquid collateral. Second, as the central bank has a zero default probability in its domestic market operations, collateral providers are willing to accept severe haircuts to obtain credit. …
According to the authors the ECB is the most transparent central bank when it comes to its collateral framework. But the latter is also complicated:
However, it is true that the ESCF is relatively broad in terms of the scope of eligible collateral and rather complicated. This is inevitable because of the diversity of financial institutions and markets in the euro area.
The Economist reported about the history of central banks and their independence. One snippet:
Typically, Richard Nixon took the bullying furthest, leaking a false story that Arthur Burns, Martin’s successor, was demanding a 50% pay rise. Attacked by the press, Burns retreated from his desire to raise interest rates.
In a VoxEU eBook, Refet Gürkaynak and Cédric Tille collect the views of central bank and academic economists on DSGE models. In the introduction to the eBook, Gürkaynak and Tille summarize these views as follows:
… there is agreement on the place of DSGE models in policy analysis. All see these models as part of the policymaker tool kit, while understanding their limitations and perceiving a similar road ahead.
In another excellent post on Moneyness, J P Koning likens the monetary system to the plot in the movie Inception, featuring
a dream piled on a dream piled on a dream piled on a dream.
Koning explains that
[l]ike Inception, our monetary system is a layer upon a layer upon a layer. Anyone who withdraws cash at an ATM is ‘kicking’ back into the underlying central bank layer from the banking layer; depositing cash is like sedating oneself back into the overlying banking layer.
Monetary history a story of how these layers have evolved over time. The original bottom layer was comprised of gold and silver coins. On top this base, banks erected the banknote layer; bits of paper which could be redeemed with gold coin. The next layer to develop was the deposit layer; non-tangible book entries that could be transferred by order from one person to another.
The foundation layer has changed over time:
One of the defining themes of modern monetary history has been the death of the original foundation layer; precious metals. … as central banks chased private banks from the banknote layer … and then gradually severed the banknote layer from the gold layer. By 1971, … [b]anknotes issued by the central bank had become the foundation layer. The trend towards a cashless world is a repeat of this script, except instead of the gold layer being slowly removed it is the banknote layer.
Fintech improves the efficiency of the layer arrangement and its connections. It also adds new layers: For instance, some payments made via mobile phone effectively transfer claims on deposits. And it may circumvent layers:
In U.K., the Bank of England is considering allowing fintech companies to bypass the banking layer by offering them direct access to the bottom-most central banking layer.
In contrast, a krypto currency like bitcoin establishes a new foundation layer, on which new layers may be built:
Even now there is talk of a new layer being developed on top of the original bitcoin foundation, the Lightning network. The idea here is that the majority of payments will occur in the Lightning layer with final settlement occurring some time later in the slower Bitcoin layer.
I fully agree with this characterization. In addition to the theme emphasized by Koning—adding layers—I would also stress the theme of untying higher-level layers from lower ones: Central bank money typically is no longer backed by gold; deposits typically are not fully backed by notes; and mobile phone credits may no longer be backed by deposits. The process of untying layers relies on social conventions and trust, and it is fragile. Important questions concern the cost of such fragility, and its necessity. Fragility is not necessary when the social cost of liquidity provision at the foundation layer is negligible.
In the FT, David Pilling reports about Somalia which has managed without central bank issued money for decades.
… up to 98 per cent of local banknotes are fake … With the help of the International Monetary Fund, Mogadishu plans to print official banknotes for the first time in more than a quarter of a century … No official Somali currency has left the presses since the Horn of Africa nation descended into clan warfare after the collapse of the government in 1991.
… warlords, businessmen and breakaway regions printed counterfeit notes or shipped them in from abroad. … several important issues, including what the government would use to back its new currency, were still being discussed. So was the question of what the conversion rate would be of fake Somali shillings for the new official ones. Use of Somali shillings, largely limited to the less well-off rural population, comes a poor third to US dollars and electronic money in what is a mostly dollarised economy. … Some dollars in circulation are also fake …
In the Journal of Economic Literature, William Roberds reviews Christine Desan’s “Making Money: Coin, Currency, and the Coming of Capitalism” and he provides his own perspective on European monetary history.
… the transition of the Bank of England’s notes from the status of experimental debt securities (in 1694) to “as good as gold” (1833) required more than a century of legal accommodation and business comfort with their use.
Desan emphasizes England’s traditions of nominalism (as opposed to metallism) and monetary restraint as well as early experiments in monetary substitution in laying the foundations for the Bank of England’s success. Lobbying played its role, too.
Roberds discusses the experience of note issuing institutions in other countries.
At the time of the Bank’s founding, there were about twenty-five publicly owned or sponsored banks operating in Europe. These institutions are largely forgotten today; most were dissolved by the early nineteenth century and only one continues in existence, Sweden’s Riksbank. …
These banks were run by and for the merchant communities in their respective cities [Amsterdam, Genoa, Hamburg, and Venice] … The existence of the early municipal banks depended on a form of nominalism more extreme than what prevailed in contemporary England. Merchants in these “banking cities” were required by law and by custom to settle all bills of exchange (the dominant form of commercial credit) with transfers of money on the ledgers of the local public bank. The practical advantage of such a restriction was that it reduced or eliminated the possibility of settlement in the debased coins … the municipal banks’ ledger money was often seen as more reliable than the typical coin in circulation …
Most of these banks failed after getting involved in speculative episodes, hyperinflation, or political turmoil. The Bank of England was lucky.
On his blog, John Cochrane reports about a Hoover panel including him, Charles Plosser, and John Taylor.
Cochrane focuses on the liability side. He favors a large quantity of (possibly interest bearing) reserves for financial stability reasons. Plosser focuses on the asset side and is worried about credit allocation by the Fed, for political economy reasons. Taylor favors a small balance sheet. Cochrane also talks about reserves for everyone, but issued by the Treasury.