Cashing out: The case for central bank digital currencies

What is a CBDC, and how does it differ from ordinary cash held in a commercial bank account?

A CBDC is a central bank digital currency. Regular bank deposits represent a liability for a commercial bank. CBDCs are liabilities of central banks—government entities that control a country’s money supply in order to regulate inflation and economic activity.

With a CBDC, you basically have an account with a central bank. Your assets are more secure because they’re not subject to “run risk” of the kind we’ve seen recently in the US with Silicon Valley Bank.

You argue that interest-bearing CBDCs are needed so that policymakers can push interest rates below zero if they also abolish conventional currency. Why would they need to do that?

Sub-zero interest rates are useful when policymakers want households and businesses to spend money instead of saving it. For the past 20 years, prior to the COVID pandemic and the recent inflation surge, interest rates have been close to zero most of the time in most advanced economies.

To stimulate the economy, central banks would have liked to push them below zero, but they couldn’t do it because there’s currency out there offering a zero rate of interest. Zero’s not great, but it’s higher than a negative rate. So, if you had a CBDC account paying a negative rate of interest, you wouldn’t keep your money in it. You’d switch to cash.

The existence of cash therefore sets a near-zero floor under the policy rates the central bank can set. This can become a problem again in the future if we experience another period of below-target inflation and near-zero interest rates.

So for negative rates, CBDC only works if you eliminate cash.

That’s right. And it’s not a far-fetched prospect. In Sweden, cash has effectively vanished— not because the government has abolished it, but because people simply don’t use it anymore. There’s no demand. The entire country has mobile coverage, and about 85% of the population has access to mobile banking.

Technically, you could eliminate cash gradually by first getting rid of large-denomination bills. This happened in the Eurozone, where new issuance of the 500-Euro note was phased out in 2019.

If the central bank set negative rates, could depositors not choose to move their money into a commercial bank that paid a better rate than the CBDC?

The commercial bank would be making losses by paying a positive interest rate on deposits while getting a negative interest rate on its lending operations. The commercial bank would have to follow the negative interest rate set by the central bank.

Some people aren’t connected to the internet. If cash was eliminated, wouldn’t those people be cut off from being able to pay for things?  

To prevent that, countries would have to create a digital currency that is available for legitimate use by everyone, both offline and online. 

What would a digital currency look like offline?

Like the connections you get today with near-field communication. NFC connections let you transfer small amounts of data wirelessly over very short distances. Tap-to-pay credit cards are an example.

So, CBDCs could actually enhance financial inclusion. An offline digital payment system could bring unbanked people into the formal financial sector. Through NFC connections, those people could transact with entities that are already integrated into the formal financial system. That would be a first step toward entering the system themselves.

What about privacy? CBDCs would make every purchase trackable. Why not preserve anonymity by using cash?

Cash does preserve anonymity. But for that very reason, it also facilitates tax evasion, money laundering, counterfeiting, bank robberies, and even the financing of terrorism.  

But you could create pseudonymous CBDC accounts using blockchain. The public identity of the wallet holder would be visible to all on the blockchain—even more public than a regular bank account. But because the accounts use pseudonyms, the identities of the digital wallets’ beneficial owners would be kept private.

Eswar Prasad, an economist at Cornell, has argued that CBDCs could become so popular that commercial banks are “starved of deposits.” That, he argues, could hurt the banking sector and damage the economy’s ability to allocate credit. Do you see this as a risk?

Not necessarily. To preserve the financial intermediation system, central banks can re-deposit their CBDC deposits in commercial banks. We will figure out a neutral way to do this, so the disruption will be manageable. People will hold CBDCs the same way they hold cash and bank deposits today.

How do you see things unfolding with CBDCs in the future? Will governments get rid of cash?

I see cash and traditional currency being phased out and replaced by interest-bearing CBDCs. Sweden, China, India, Nigeria, and other countries are experimenting with CBDCs, and I believe that eventually, most central banks will issue their own. Five to 10 years from now, CBDC accounts will be part of the new normal.