Interview, Riksbank RN, 2021

Riksbank Research News 2021, December 2021. PDF (pp. 2–3), HTML.

Q: You have been leader of the CEPR Research and Policy Network on FinTech and Digital Currencies since 2021 and explored issues at the heart of monetary theory and payment systems in your research. What do you think is new about digital central bank money and what makes it different from other digital means of payment?

A: Societies have been using digital means of payment for decades. Commercial banks use digital claims against the central bank, “reserves,” to pay each other. Households and firms use digital claims against commercial banks, “deposits,” as well as claims on such deposits, as money. Financial innovations typically improved the convenience for users or helped build additional layers of claims on top of each other, fostering fractional reserve banking and raising money multipliers.

Recently, new digital instruments have appeared on the fringes of the financial system. Some think of them as currencies and others as mere database entries. These instruments exploit the fact that smart ways of managing information, and even smarter approaches to providing incentives in anonymous, decentralized networks can replicate some functions of conventional monies. Monetary theorists are not surprised. They have debated for decades to what extent money is, or is not a substitute for a large societal database. The information technology revolution has made this debate much less theoretical.

Of course, the new entrants such as Bitcoin have not been very successful so far when it comes to actually creating substitute monies. But they have been quite successful in terms of creating new assets, mostly bubbles. Bubbles are also a great mechanism for their creators to extract resources from other people.

What is new about digital central bank money for the general public (central bank digital currency, CBDC) is that households and firms would no longer be restricted to cash when they wanted to pay using a central bank (i.e., government) liability. That is, banks would lose a privilege and households and firms would gain an option. CBDC, which I like to think of as “Reserves for All,” seems natural when you consider the history of central banking. It also seems natural when you consider that many governments strongly discourage the use of cash. Nevertheless, compared with the status quo, “Reserves for All” would amount to a major structural change.

Q: What do you think are the main challenges of issuing a CBDC?

A: From a macroeconomic perspective, introducing “Reserves for All” could have major implications. The balance sheets of central banks would likely expand while commercial banks would likely lose some deposits as a source of funding. Mechanically, they would reduce their asset holdings or attract other sources of funding. The question is, which assets they would shed, and subject to which terms and conditions they would attract new funding. These are important questions because banks play a key role in the transmission of monetary policy to main street.

While many central bankers are concerned about the implications of CBDC for bank assets and funding costs academic research conveys a mixed picture. To assess the consequences of “Reserves for All” it is natural to first ask what it would take to perfectly insulate banks and the real economy from the effects of CBDC issuance. As it turns out, the answer is “not much:” Under fairly general conditions the central bank holds a lot of power and can neutralize the implications of CBDC for macroeconomic outcomes.

Of course, central banks might choose to implement other than the neutral policies. In my view, this is in fact very likely, for reasons related to the political economy of banking and central banking. On the one hand, CBDC would make it even harder for central banks to defend their independence. On the other hand, CBDC would increase the transparency of the monetary system and trigger questions about the fair distribution of seignorage. On top of this, “Reserves for All” might trigger demands for the removal of other “bank privileges:” Interest groups might request LOLR-support, arguing that they are systemically important and just temporarily short of liquidity. Others might want to engage in open market operations with the central bank.

Beyond macroeconomics and political economy, CBDC could substantially change the microeconomics of banking and finance. In the current, two-tiered system there is ample room for complementarities between financing, lending, and payments. The information technology revolution strengthens these complementarities but it also generates new risks or inefficiencies. How the connections between money and information currently change is the subject of ongoing research. I don’t think we have been able to draw robust conclusions yet as to what role CBDC would play in this respect.

Q: Should we, and will we have CBDCs in the near future?

A: Some countries have already decided in favor. Others, like the Riksbank I believe, are still on the sidelines, thinking about the issues, watching, and preparing. Yet others have only recently taken the issue more seriously, mostly because of the Libra/Diem shock in June 2019, which made it clear to everybody that the status quo ceases to be an option.

I think the normative question is still unanswered. Not only does CBDC have many consequences, which we would like to better understand. There are also the unknown consequences that we might want to prepare ourselves for. Moreover, many of the problems that CBDC could potentially address might also allow for different solutions; the fact that CBDC could work does not mean that CBDC is the best option.

In a recent CEPR eBook* several authors share that view, which suggests a case-by-case approach. CBDC might be appropriate for one country but not for another, for instance because cash use has strongly declined in Sweden and this may favor CBDC (as Martin Flodén and Björn Segendorf discuss in their chapter) while the same does not apply in the US or elsewhere.

Regarding the positive question, I think that many more countries will decide to introduce “Reserves for All,” and quite a few of them in the next five years. One reason is that it is politically difficult to wait when others are moving ahead. Another is the fear of “dollarization,” not only in countries with less developed financial markets. The strongest factor, I believe, is the fear that central banks might lose their standing in financial markets. This is connected with the important question, which the Riksbank has been asking early on, whether in the absence of CBDC declining cash circulation could undermine trust in central bank money.

Among the eBook authors, most but far from all expect that a CBDC in a developed economy would resemble deposits in terms of user experience. Almost everyone expects that private banks and service providers rather than the central bank itself would interact with end-users. I share these views. But there is disagreement as to whether digital currencies would be interest bearing and how strictly they would protect privacy. I believe that it is also unclear how strictly central banks would enforce KYC regulation or holding restrictions on foreigners. These two factors might critically affect the threats to monetary sovereignty in other countries, and as a consequence they might shape the chain reaction of adoptions.

What seems clear to me is that the implications of CBDC go far beyond the remit of central banks. Parliaments and voters therefore should have the final say.

* Dirk Niepelt (2021), editor: “CBDC: Considerations, Projects, Outlook”, CEPR eBook. Changes in the research staff