CBDC must be combined with greater accountability


Martina Fraschini, Luciano Somoza and Tammaro Terracciano are PhD students at the Swiss Finance Institute. Here, they explained why the impact of the central bank’s digital currency on the balance sheet of currency guardians needs to be scrutinized more closely.

Since the 2008 financial crisis, central bank governors have become reassuringly powerful technocrats. Whether it is market turmoil, epidemics, or climate change and inequality, they always seem to try to do something about it.

This kind of omnipotence is possible thanks to their special ability to create money out of thin air.

The impact of these interventions on the institution itself is very obvious from the inflation of the balance sheets of the European Central Bank and the Federal Reserve in the past 15 years:

© FRED Federal Reserve Bank of St. Louis

It has not been ignored. Questions are being raised. Who decides the target assets? What do permanent low interest rates mean for public policy? Does the central bank monetize debt? It is hard not to conclude that the larger the balance sheet, the more politicized the central bank.

Soon, the scale may increase further.

The introduction of central bank digital currency (CBDC) seems to be a problem When not if. Its advocates emphasize technological advantages and believe that it can promote financial inclusion and smooth cross-border payments. Although this is controversial, What we want to focus on here is the impact of CBDC on the balance sheet.

CBDC will be the digital equivalent of cash, and from an accounting point of view, its function will be similar. When a depositor withdraws $1,000 in cash, her bank needs to purchase banknotes from the central bank. In order to settle the transaction, the commercial bank paid its reserves to the central bank, and the reserve was reduced by $1,000. From the central bank’s point of view, this operation is neutral because one type of liability (reserves) is simply converted to another (cash).

If depositors want to buy CBDC instead of cash, the situation will be the same. The bank will reduce its reserves, and the central bank will credit depositors to its personal CBDC accounts. So far so good.

The main difference between cash and CBDC is the size of your pocket. The demand for cash is hardly a problem; hoarding large amounts of banknotes is impractical and dangerous. However, physical restrictions do not apply to digital dollars. If a large part of deposits are converted into CBDC and the bank does not have sufficient reserves, any additional digital dollars created will mean an increase in the size of the central bank’s balance sheet.

Let’s do some rough calculations.

In the United States, there are 17.2 tons of bank deposits.At the same time, the Federal Reserve have Of the debt worth 8 trillion US dollars, 3.9 trillion US dollars are bank reserves and 2.2 trillion US dollars are banknotes. It is reasonable to assume that the bank still wants to keep some reserves and some cash will continue to circulate. Therefore, it is assumed that the system can handle up to $4.5 trillion in CBDC deposits (or slightly more than 25% of bank deposits) without significant impact on the size of the balance sheet.

If the demand for CBDC is less than 25% of bank deposits, we will only see bank reserves and banknotes being transferred to CBDC. Commercial banks may even welcome such transfers, because deposits are expensive to manage and reserves pay very little interest. However, this changes the type and number of peers that the central bank must deal with, because the millions of retail depositors are very different from a few banks. If the central bank decides to resume its expansionary policy and shrink its balance sheet, it will face millions of inelastic small retailers. This can make things quite complicated. The design of CBDC can reduce but not significantly change the described mechanism. Even if commercial banks distribute CBDC, millions of retailers will file claims against the central bank.

If the demand for CBDC is higher than 25% of bank deposits, the situation will be different. Once reserves and banknotes are absorbed, the banking industry will face pressure because it must liquidate other assets to transfer deposits. At this time, the size of the Fed’s balance sheet will increase with each increase of CBDC by one unit. In the extreme case where all deposits are eventually deposited in the CBDC, the Fed’s balance sheet will more than double in size. The central bank must also decide what to hold on these deposits. Treasury bonds and corporate bonds? This will further depress interest rates and make the government more dependent on Fed funds. Bank debt? The idea of ??returning money to the bank may be attractive, but who decides which banks to provide funds to? under what conditions?The central bank will inevitably choose Winners and losers.

Either way, monetary policy will change dramatically. The central bank will establish closer ties with people’s wallets, and the intermediary activities of the private banking sector will be less than it is now. It can easily implement various currency experiments, such as helicopter money or deep negative interest rates directly to the people. In other words, the central bank will acquire a larger monetary superpower.

And, just like Spider-Man, they must realize that the greater the ability, the greater the responsibility.

The CBDC calls for a deep reflection on the central bank’s responsibilities, independence, and ultimately accountability. In his 1968 paper on the central bank, The role of monetary policyMilton Friedman pointed out the risk of splitting macroeconomic policies among multiple decision makers, because this will lead to “diversification of responsibilities and promote the shirk of responsibilities in uncertain and difficult times…”. This concern is very real. In this environment, it may not be surprising that the recent European Central Bank and former Fed governors Mario Draghi and Janet Yellen are now in political positions. A strong and proactive central bank is the perfect excuse for the government. In times of economic downturn, the government can avoid taking responsibility because the central bank will step in and save the situation. In good times, the government has no pressure to reform and can do nothing. The long-term effects can be said to be excessive debt, inequality, reliance on asset prices, and the constant pursuit of new and more powerful monetary instruments.

The greater the power, the greater the responsibility. A central bank with monetary superpowers, direct guarantees of people’s savings, combating climate change and social justice, and the active participation of its predecessors in politics, is no longer a dull technocratic institution. Enthusiasm for new technologies should not hijack the debate about CBDC; taking such steps can have a serious impact on financial stability and social welfare. In this case, we must ask in depth whether the launch of officially recognized digital currencies is truly in line with the independence of the central bank and the entire public interest. This is of vital importance.



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