Tag Archives: Reserves for all

“Digital Finance bedroht Geld- und Währungshoheit (Digital Finance Threatens Monetary Sovereignty),” NZZ, 2022

Neue Zürcher Zeitung, February 17, 2022. PDF.

  • The federal council’s digital finance strategy focuses on regulation.
  • There are limits to this strategy when financial markets operate globally and virtually.
  • Preserving monetary sovereignty requires an attractive national currency.
  • Carrots, not only sticks.
  • An attractive currency is not only stable but also usable in digital form.

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

“Reserves for All: Political Rather Than Macroeconomic Risks,” CEPR, 2021

Chapter 5 in the CEPR eBook, November 24, 2021. HTML.

From the conclusion:

From a macroeconomic perspective, central banks can largely neutralise the consequences of CBDC. What is highly uncertain, however, is whether they would choose to do so – the political risks of ‘Reserves for All’ are first-order. The decision for or against CBDC thus should not only reflect the assessment of economic trade-offs, but also whether societies are confident in their ability to efficiently manage conflicts of interest. If not, and if they fear that the introduction of CBDC could further politicise banking and central banking, then the introduction of CBDC might constitute a risky regime change. It will be interesting to see how different [countries] judge this risk.

“CBDC: Considerations, Projects, Outlook,” CEPR/VoxEU, 2021

CEPR eBook, November 24, 2021. HTML.

VoxEU, November 24, 2021. HTML.

Retail central bank digital currency has morphed from an obscure fascination of technophiles and monetary theorists into a major preoccupation of central bankers. Pilot projects abound and research on the topic has exploded as private sector initiatives such as Libra/Diem have focused policymakers’ minds and taken the status quo option off the table. In this eBook, academics and policymakers review what we know about the economic, legal, and political implications of CBDC, discuss current projects, and look ahead.

German Banks Send Mixed Signals on Digital Euro

In the FAZ, Christian Siedenbiedel reports that Deutsche Bank questions whether a digital Euro as envisioned by the ECB (i.e., with tight quantity restrictions) would be successful:

Die Argumentation geht so: Die EZB will den digitalen Euro einführen, um auf den verstärkten Währungswettbewerb zu antworten. … Um sich vor solchem Machtverlust sowohl durch Digitalgeld von anderen Notenbanken („Krypto-Dollars“) als auch durch privates Digitalgeld („Global Stable Coins“) zu schützen, treibe die EZB den Digitaleuro voran. Also aus längerfristigen politischen Motiven. Dabei sei unklar, ob der digitale Euro sich international am Markt durchsetzen könne und ob die Menschen in der Eurozone dafür überhaupt Bedarf hätten. “Das Design des digitalen Euros, soweit bisher bekannt, lässt erwarten, dass die potentiellen Nutzer kaum einen Unterschied zu bestehenden Bezahloptionen erkennen werden”.

Update: From the dbresearch document prepared by Heike Mai:

Lifting the limits on how much each user can hold would change the situation entirely, allowing a massive outflow of bank deposits into the digital euro. As a result, lending decisions and money creation would shift from the decentralised, privately owned banking sector to a central, state-run authority: the ECB. In this case, Europe would face the fundamental question of which type of monetary and financial system it wants. The answer to that would have to come from democratically elected representatives.

The German Banking Industry Committee sees a central role for the digital Euro, however, according to a new paper:

In a policy paper, the German Banking Industry Committee (GBIC) for the first time sets out detailed thoughts on the design of a “digital euro”. In this paper, experts from Germany’s five national banking associations draw up an ecosystem of innovative forms of money that extends far beyond the idea of digitalised central bank money, which is referred to as Central Bank Digital Currency (CBDC). The ECB will probably launch the project for a digital euro in mid-July 2021.

“To be successful, the digital euro must do three things: It must be as easy for consumers to handle as cash. It must be viable in the long term for business enterprises, e.g. for automated machine-to-machine payments. And the digital euro must be well embedded in our delicately balanced, carefully secured and highly regulated European financial system because this system guarantees safe and fair access to financial and banking services for everyone in Europe”, notes Dr Joachim Schmalzl, executive member of the Board of Management of the German Savings Bank Association (DSGV), which is currently the lead coordinator for the German Banking Industry Committee.

In the opinion of the experts from Germany’s five national banking associations, issuing money should remain the responsibility of credit institutions in the proven two-tier banking system [my emphasis], even if the digital euro becomes legal tender like cash. For this reason, the ecosystem of digital money which they propose is made up of three key elements:

  • retail CBDC for private use
  • wholesale CBDC for commercial and savings banks
  • tokenised commercial bank money for use in industry

Retail CBDC issued by the central bank is to be used by private individuals in the euro area in the same way as cash for everyday payments, e.g. to retailers or government agencies. It should be possible to use the digital euro like cash, anonymously and offline. For this purpose, credit institutions will provide consumers in Europe with “CBDC wallets”, i.e. electronic wallets.

Wholesale CBDC issued by the central bank is to be used for the capital markets and interbank transfers. The GBIC’s experts are calling for this special form of the digital euro partly because, by adopting this approach, the ECB would be able to include further digitalisation of central bank accounts in its project. The ultimate aim is to achieve improvements which can benefit consumers, enterprises and also the banking sector.

Tokenised commercial bank money, which will be made available by commercial and savings banks, is to complement the two forms of digital central bank money, in particular to meet corporate demand arising from Industry 4.0 and the Internet of Things. Tokenised commercial bank money could facilitate transactions based on “smart” – i.e. automated – contracts and thus increase process efficiency.

“Increasing process digitalisation and automation will provide completely new opportunities for Europe’s enterprises. The banking sector is ready to provide new solutions for its corporate customers by issuing innovative forms of money. The ECB must define the necessary framework that will enable Europe’s banking sector and real economy to make reasonable use of the new opportunities”, Joachim Schmalzl observed on behalf of the GBIC.

I share the skepticism of DB research. And I can understand that banks prefer to maintain the two-tiered system while pushing for broader and more efficient payment options for their business clients.

“Money Creation, Bank Profits, and CBDC,” VoxEU, 2021

VoxEU, February 5, 2021. HTML.

Based on CEPR DP 15457, I assess possible implications of the introduction of retail CBDC for bank profits. The model implies annual implicit subsidies to U.S. banks of up to 0.8 percent of GDP during the period 1999-2017.

John Cochrane about CBDC and Me

Writing about CBDC, John Cochrane makes it clear that he is in favor. He links to my work and writes

Dirk Niepelt has written a lot about CBDC theory, including reserves for all in 2015, a recent Vox-EU summary and papers,  here with Markus Brunnermeier a JME paper “CBDC coupled with central bank pass-through funding need not imply a credit crunch nor undermine financial stability,” a follow up including “The model implies annual implicit subsidies to U.S. banks of up to 0.8 percent of GDP during the period 1999-2017.”  Here  “reserves for all” “does not affect macroeconomic outcomes,”

“Monetary Policy with Reserves and CBDC: Optimality, Equivalence, and Politics,” CEPR, 2020

CEPR Discussion Paper 15457, November 2020. PDF (local copy).

We analyze policy in a two-tiered monetary system. Noncompetitive banks issue deposits while the central bank issues reserves and a retail CBDC. Monies differ with respect to operating costs and liquidity. We map the framework into a baseline business cycle model with “pseudo wedges” and derive optimal policy rules: Spreads satisfy modified Friedman rules and deposits must be taxed or subsidized. We generalize the Brunnermeier and Niepelt (2019) result on the macro irrelevance of CBDC but show that a deposit based payment system requires higher taxes. The model implies annual implicit subsidies to U.S. banks of up to 0.8 percent of GDP during the period 1999-2017.

Central Banks Have Accepted a Future Retail CBDC

Recent indications:

Related recent developments:

“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.

“Reserves For All? Central Bank Digital Currency, Deposits, and their (Non)-Equivalence,” IJCB, 2020

International Journal of Central Banking. PDF.

This paper offers a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public hold electronic central bank money and transact with it. I propose an equivalence result according to which a marginal substitution of outside money (e.g., RFA) for inside money (e.g., deposits) does not affect macroeconomic outcomes. I identify key conditions for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate the analysis to common arguments found in discussions on RFA and point to inconsistencies and open questions.

China’s Digital Renminbi

In the NZZ, Matthias Müller reports how China’s CBDC plans progress:

In China beginnen nun im Viertel Xiangcheng, das zu der unweit von Schanghai gelegenen Millionenstadt Suzhou gehört, in einem geschlossenen System erste Tests. …

Die PBoC dürfte ein zweistufiges System entwickelt haben. Auf der ersten Ebene wird die digitale Währung an die Geschäftsbanken ausgegeben. Auf der zweiten Ebene können dann die Haushalte und Unternehmen den digitalen Yuan abheben und verwenden. …

In Suzhou werden im April in einem ersten Schritt die digitalen Geldbeutel auf die Smartphones ausgewählter Testpersonen aufgespielt, wobei es sich um Angehörige des öffentlichen Diensts handelt.

Marshall Islands CBDC

The Marshall Islands CBDC project moves forward. Algorand, the project partner, reports that

blockchain for the world’s first national digital currency, the Marshallese sovereign (SOV), will be built using Algorand technology. The SOV will circulate alongside the US dollar and help the Marshall Islands efficiently operate in the global economy.

e-krona Pilot

The Riksbank starts a pilot project with Accenture to develop a technical solution for a retail e-krona.

Users shall be able to hold e-kronor in a digital wallet, make payments, deposits and withdrawals via a mobile app. The user shall also be able to make payments via wearables, such as smart watches, and cards.

The pilot runs for a year, on a distributed ledger, according to the Riksbank’s press release. More detailed information is contained in this note.

 

 

 

“Цифровые деньги и цифровые валюты центральных банков: главное, что нужно знать,” Econs, 2020

Econs (a non-profit project of the communications department of the Russian central bank), February 13, 2020. HTML.

Russian version of my VoxEU column on digital money and CBDC. What are we actually talking about? What do we know? And what should policymakers do? I discuss the following points:

  • Finance has been digital forever – what’s new about ‘digital money’?
  • Does the nature of money change?
  • What is central bank digital currency?
  • What is the link between CBDC and the blockchain?
  • Would CBDC have macroeconomic effects?
  • Would CBDC foster bank disintermediation and bank runs?
  • Why consider CBDC at all?
  • What opportunities does CBDC offer?
  • Where do the risks lie?
  • Do the opportunities justify the risks?
  • Do central banks have a choice?

“Digital Money and Central Bank Digital Currency: An Executive Summary for Policymakers,” VoxEU, 2020

VoxEU, February 3, 2020. HTML.

What are we actually talking about? What do we know? And what should policymakers do? I discuss the following points:

  • Finance has been digital forever – what’s new about ‘digital money’?
  • Does the nature of money change?
  • What is central bank digital currency?
  • What is the link between CBDC and the blockchain?
  • Would CBDC have macroeconomic effects?
  • Would CBDC foster bank disintermediation and bank runs?
  • Why consider CBDC at all?
  • What opportunities does CBDC offer?
  • Where do the risks lie?
  • Do the opportunities justify the risks?
  • Do central banks have a choice?

“Libra Paves the Way for Central Bank Digital Currency,” finews and WNM, 2019

My VoxEU column now also on finews and World News Monitor, September 17, 2019.

Digital currencies involve tradeoffs. Libra resolves them less favorably than other projects, and less favorably than CBDC.

When confronted with the choice between the status quo and a new financial architecture with CBDC, most central banks have responded cautiously. But Libra or its next best replica will take this choice off the table – the status quo ceases to be an option. The new choice for monetary authorities and regulators will be one between central bank managed CBDC on the one hand and – riskier – private digital tokens on the other. Central banks have a strong interest to maintain control over the payment system as well as the financial sector more broadly and to defend the attractiveness of their home currency. Nolens volens, they will therefore introduce ‘Reserves for All’ or promote synthetic CBDCs. In economics, things take longer than one thinks they will, as Rudi Dornbusch quipped, but then they happen faster than one thought they could.

“Libra Paves the Way for Central Bank Digital Currency,” VoxEU, 2019

VoxEU, September 12, 2019. HTML.

Digital currencies involve tradeoffs. Libra resolves them less favorably than other projects, and less favorably than CBDC.

When confronted with the choice between the status quo and a new financial architecture with CBDC, most central banks have responded cautiously. But Libra or its next best replica will take this choice off the table – the status quo ceases to be an option. The new choice for monetary authorities and regulators will be one between central bank managed CBDC on the one hand and – riskier – private digital tokens on the other. Central banks have a strong interest to maintain control over the payment system as well as the financial sector more broadly and to defend the attractiveness of their home currency. Nolens volens, they will therefore introduce ‘Reserves for All’ or promote synthetic CBDCs. In economics, things take longer than one thinks they will, as Rudi Dornbusch quipped, but then they happen faster than one thought they could.

“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.

Jean-Pierre Landau Argues for CBDC

In the FT, Jean-Pierre Landau argues that central banks should introduce central bank digital currency:

A CBDC would protect the pre-eminence of public money in a digitalised economy. It would maintain effective convertibility of private into public money and provide a defence against digital dollarisation.

For that purpose, a CBDC should be as close as possible to cash. It should be a complement, not a substitute, to bank deposits. It should not carry interest. Whether it should be anonymous, as cash currently is in certain limits, is a fundamental social choice. It must be openly debated as the digitalisation of money forces us to reconsider and rethink the place of privacy in our lives.

“Digitales Zentralbankgeld (Central Bank Digital Currency),” FuW, 2019

Finanz und Wirtschaft, June 29, 2019. PDF. Related article in Oekonomenstimme, July 9, 2019. HTML.

    • It is not central bank digital currency (CBDC) per se which might act as a game changer in financial markets. What will be key is how central banks accommodate the introduction of CBDC.
    • In principle, this accommodation can go very far, to the point where the introduction of CBDC does not affect macroeconomic outcomes.
    • But such complete accommodation is unlikely. On the one hand, central banks will want to exploit the new monetary policy options that CBDC opens up; that is, central banks will not choose to fully accommodate.
    • On the other hand, the introduction of CBDC increases transparency and this will increase political pressure; as a consequence, central banks will not be able to fully accommodate.

The Future of Money – CBDC and Beyond

At the conference of “Positiva Pengar” and “Monetative” in Stockholm, I argued that it is not so much the introduction of CBDC which would make a difference, but the policies accompanying such an introduction. This view is backed by research of Markus Brunnermeier and myself, as well as by myself.

Many of the proponents of the sovereign money movement appeared open to the argument. Some of the followers, however, did not; they associate CBDC with many benefits that money, in whatever form, will not be able to deliver.