Tag Archives: Money

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

David Graeber’s “Debt”

Goodreads rating 4.19.

Graeber’s book contains many interesting historical observations but lacks a concise argument to convince a brainwashed neoclassical economist looking for coherent arguments on money and debt. After 60 pages, 340 more seemed too much.

Chapter one:

… the central question of this book: What, precisely, does it man to say that our sense of morality and justice is reduced to the language of a business deal? What does it mean when we reduce moral obligations to debts? … debt, unlike any other form of obligation, can be precisely quantified. … to become simple, cold, and impersonal … transferable.

… money’s capacity to turn morality into a matter of impersonal arithmetic—and by doing so, to justify things that would otherwise seem outrageous or obscene. … the violence and the quantification—are intimately linked. … the threat of violence, turns human relations into mathematics.

…The United States was one of the last countries in the world to adopt a law of bankruptcy: despite the fact that in 1787, the Constitution specifically charged the new government with creating one, all attempts were rejected, or quickly reversed, on “moral grounds” until 1898.

… historically, credit money comes first [before bullion, coins]

… ages of virtual credit money almost invariably involve the creation of institutions designed to prevent everything going haywire—to stop the lenders from teaming up with bureaucrats and politicians to squeeze everybody dry … by the creation of institutions designed to protect debtors. The new age of credit money we are in seems to have started precisely backwards. It began with the creation of global institutions like the IMF designed to protect not debtors, but creditors.

… the book begins by attempting to puncture a series of myths—not only the Myth of Barter … but also rival myths about primordial debts to the gods, or to the state … Historical reality reveals [that the state and the market] have always been intertwined. … all these misconceptions … tend to reduce all human relations to exchange … [but] the very principle of exchange emerged largely as an effect of violence … the real origins of money are to be found in crime and recompense, war and slavery, honor, debt, and redemption. … an actual history of the last five thousand years of debt and credit, with its great alternations between ages of virtual and physical money …

… many of Adam Smith’s most famous arguments appear to have been cribbed from the works of free market theorists from medieval Persia …

Chapter two (“The Myth of Barter”) contains questionable claims about economics as well as interesting historical facts (or claims?):

When economists speak of the origins of money … debt is always something of an afterthought. First comes barter, then money; credit only develops later. …

Barter … was carried out between people who might otherwise be enemies …

… “truck and barter”’ [in many languages] literally meant ”to trick, bamboozle, or rip off.”

What we now call virtual money came first. Coins came much later, … never completely replacing credit systems. Barter, in turn, … has mainly been what people who are used to cash transactions do when for one reason or another they have no access to currency.

Chapter three (“Primordial Debts”) argues the the myth of barter is central to the discourse of economics, which according to Graeber downplays the state as opposed to markets, exchange, and individual choice. He tries to confront this view with Alfred Mitchell-Innes’ credit theory of money, Georg Friedrich Knapp’s state theory of money, the Wizard of Oz (i.e. “ounce”), and John Maynard Keynes (original?) claim that banks create money.

In all Indo-European languages, words for “debt” are synonymous with those for “sin” or “guilt,” illustrating the links between religion, payment and the mediation of the sacred and profane realms by “money.” [money-Geld, sacrifice-Geild, tax-Gild, guilt]

Wikipedia article on the book:

A major argument of the book is that the imprecise, informal, community-building indebtedness of “human economies” is only replaced by mathematically precise, firmly enforced debts through the introduction of violence, usually state-sponsored violence in some form of military or police.

A second major argument of the book is that, contrary to standard accounts of the history of money, debt is probably the oldest means of trade, with cash and barter transactions being later developments.

Debt, the book argues, has typically retained its primacy, with cash and barter usually limited to situations of low trust involving strangers or those not considered credit-worthy. Graeber proposes that the second argument follows from the first; that, in his words, “markets are founded and usually maintained by systematic state violence”, though he goes on to show how “in the absence of such violence, they… can even come to be seen as the very basis of freedom and autonomy”.

Reception of the book was mixed, with praise for Graeber’s sweeping scope from earliest recorded history to the present; but others raised doubts about the accuracy of some statements in Debt, as outlined below in the section on “critical reception”.

 

“Digital Money, Payments and Banks,” CEPR/IESE Report, 2020

Discussion of Antonio Fatás’ chapter in Elena Carletti, Stijn Claessens, Antonio Fatás, Xavier Vives, The Bank Business Model in the Post-Covid-19 World, CEPR/IESE report, London, June 2020. PDF.

Antonio’s chapter offers a rich overview of the dramatic changes in the world of money and banking that we have seen in recent years. I focus on two themes: the nature of money and how it relates to these developments, and the government’s response to the structural changes we observe.

I discuss the price of money, its fundamental value, store-of-value bubble, and liquidity bubble components; the opaque legal tender concept and the absurd situation that governments outlaw the use of government money (contrary to what some theories would imply); the role of trust in a world without cash; and the substitution of money by smart contracts tied to a database.

And I comment on the many facets of digitalization; the time lag between the origination of new business models and regulatory catch-up; and on central bank digital currency as a key element of structural change in the financial system.

“On the Equivalence of Private and Public Money,” JME, 2019

Journal of Monetary Economics, with Markus Brunnermeier. PDF.

When does a swap between private and public money leave the equilibrium allocation and price system unchanged? To answer this question, the paper sets up a generic model of money and liquidity which identifies sources of seignorage rents and liquidity bubbles. We derive sufficient conditions for equivalence and apply them in the context of the “Chicago Plan”, cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). Our results imply that CBDC coupled with central bank pass-through funding need not imply a credit crunch nor undermine financial stability.

“On the Equivalence of Private and Public Money,” JME, 2019

Accepted for publication in the Journal of Monetary Economics, with Markus Brunnermeier. (NBER wp.)

When does a swap between private and public money leave the equilibrium allocation and price system unchanged? To answer this question, the paper sets up a generic model of money and liquidity which identifies sources of seignorage rents and liquidity bubbles. We derive sufficient conditions for equivalence and apply them in the context of the “Chicago Plan”, cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). Our results imply that CBDC coupled with central bank pass-through funding need not imply a credit crunch nor undermine financial stability.

Libra

In the FT, Hannah Murphy reports about Facebook’s launch of Libra.

Lots of skepticism in the comments section.

And Hannah Murphy reports that

[p]ositive Money, a consumer campaign group, attacked the proposal. “Our money is increasingly in the hands of a small number of banks and payment companies, and we should avoid ceding further control to unaccountable corporate interests. Facebook’s plans pose alarming implications for privacy and power in the economy,” said David Clarke, the head of policy at the group.

“On the Equivalence of Private and Public Money,” CEPR, 2019

CEPR Discussion Paper 13778, June 2019, with Markus Brunnermeier. PDF. (Local copy of NBER wp.)

We develop a generic model of money and liquidity that identifies sources of liquidity bubbles and seignorage rents. We provide sufficient conditions under which a swap of monies leaves the equilibrium allocation and price system unchanged. We apply the equivalence result to the “Chicago Plan,” cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). In particular, we show why CBDC need not undermine financial stability.

“On the Equivalence of Private and Public Money,” NBER, 2019

NBER Working Paper 25877, May 2019, with Markus Brunnermeier. PDF. (Local copy.)

We develop a generic model of money and liquidity that identifies sources of liquidity bubbles and seignorage rents. We provide sufficient conditions under which a swap of monies leaves the equilibrium allocation and price system unchanged. We apply the equivalence result to the “Chicago Plan,” cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). In particular, we show why CBDC need not undermine financial stability.

“Digital Money: Private versus Public,” VoxEU Book, 2019

In Antonio Fatás, editor, The Economics of Fintech and Digital Currencies, VoxEU book, London, March 2019, with Markus Brunnermeier. PDF.

We address five key concerns that are frequently put forward:
1. Aren’t digital currencies just a hype, now that crypto ‘currencies’ like Bitcoin have proved too volatile and expensive to serve as reliable stores of value or mediums of exchange? This confuses things. A central bank digital currency (CBDC) is like cash, only digital; Alipay, Apple Pay, WeChat Pay, and so on are like deposits, only handier; and crypto currencies are not in any way linked to typical currencies, but they live on the blockchain.
2. Doesn’t a CBDC or ‘Reserves for All’ choke investment by cutting into bank deposits? No, because new central bank liabilities (namely, a CBDC) would fund new investments, and this would not in any way imply socialism or a stronger role of government in investment decisions.
3. Wouldn’t a CBDC cut into the profits that banks generate by creating deposits? Less money creation by banks would certainly affect their profits. But if this were deemed undesirable (by the public, not by shareholders and management) then banks could be compensated.
4. Wouldn’t ‘Reserves for All’ render bank runs more likely, undermining financial stability? We argue that, in fact, the opposite seems more plausible.
5. Aren’t deposit insurance, a CBDC, Vollgeld/sovereign money, and the Chicago Plan all alike? There are indeed close parallels between the different monetary regimes. In a sense, “money is changing and yet, it stays the same”.

Does CBDC Increase Run Risk?

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.

Koning writes:

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.

“Für elektronisches Zentralbankgeld (In Favor of Central Bank Digital Currency),” NZZ, 2018

NZZ, March 15, 2018. PDF. Ökonomenstimme, March 19, 2018. HTML

  • CBDC is not the same as krypto currencies.
  • The case against CBDC is not at all obvious; CBDC has costs and benefits.
  • Switzerland should not dismiss CBDC too quickly.
  • (The title of the article is misleading, it is not mine. I argued for openness in the discussion rather than for adoption.)

Cash Demand

On VoxEU, Clemens Jobst and Helmut Stix argue that

… cash balances for transactions comprise only a modest share of overall cash demand (a rough estimate of 15% might be a good guess across richer economies). … changes in currency in circulation are dominated by motives like hoarding. While transaction demand is reasonably well researched … still too little is known about non-transaction demand in general, and recent increases in particular.

A Taxonomy of Money

In a BIS Quarterly Review article, Morten Bech and Rodney Garratt offer a taxonomy of money, with special emphasis given to central bank issued digital and crypto currency. They stress four dimensions:

issuer (central bank or other); form (electronic or physical); accessibility (universal or limited); and transfer mechanism (centralised or decentralised). The taxonomy defines a CBCC as an electronic form of central bank money that can be exchanged in a decentralised manner known as peer-to-peer, meaning that transactions occur directly between the payer and the payee without the need for a central intermediary. This distinguishes CBCCs from other existing forms of electronic central bank money, such as reserves, which are exchanged in a centralised fashion across accounts at the central bank.

On Cheques

On his blog, JP Koning discusses the versatility of cheques:

  • A cheque instructs a bank to transfer deposits.
  • It is a derivative on bank deposits.
  • A post dated cheque serves as debt instrument, e.g., vis-a-vis pay day lenders.
  • An uncashed cheque may serve as money if marked “to bearer” or endorsed by the recipient. Laws grant cheques currency status.
  • A cheque may be used for payments even if other payment mechanisms break down. During the Irish banking strike of 1970, “for six months post-dated cheques circulated as the main form of money.”
  • A cheque can be used by the unbanked.

This combination of negotiability, robustness, openness, and decentralization means that long before bitcoin and the cryptocoin revolution, we already had a decentralized payments system that allowed pretty much everyone to participate and, indeed, fabricate their own personal money instruments! …

… a whole language of cheques has emerged, allowing for significant customization. By putting crossings on cheques, like this the cheque writer is indicating that the only way to redeem it is by depositing it, not cashing it. This means that the final user of the cheque will be easy to trace, since they will be associated with a bank account. Affix the words non-negotiable within the cross on the front of the cheque and it loses its special status as currency. Should it be stolen and passed off to an innocent third-party, the victim can now directly pursue the third-party for restitution. To even further limit the power of subsequent users to use the cheque as money, the writer can indicate the account to which the cheque must be deposited. This language of checks can be used not only by those that have originated the cheque, but also by those that receive it in payment. On the back of any check, any number of endorsements can be written, effectively allowing for the conversion of someone else’s payment instructions into your own unique medium of exchange.

Currency Status

On his blog (here and here), JP Koning discusses currency status:

… laws that … grant … currency status. … Say that person A is carrying some sort of financial instrument in their pocket and it is stolen. The thief uses it to buy something from person B, who accepts it without knowing it to be stolen property. If the financial instrument has not been granted currency status by the law, then person B will be liable to give it back to person A. If, however, the instrument is currency, then even if the police are able to locate the stolen instrument in person B’s possession, person B does not have to give up the stolen [instrument] to person A. We call these special instruments negotiable instruments.

Stable Long-Run Money Demand

On VoxEU, Luca Benati, Robert Lucas, Juan Pablo Nicolini, and Warren Weber argue that long-run money demand in many countries is rather stable.

… using a specific, narrow monetary aggregate, M1, we study a dataset comprising 32 countries since the mid-19th century (Benati et al. 2016). The main finding of this large-scale investigation is that, contrary to conventional wisdom, in most cases statistical tests do identify with high confidence a long-run equilibrium relationship between either M1 velocity and a short-term interest rate, or M1, GDP, and a short rate – that is, a long-run money demand.

Money, Banking, and Dreams

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.