Benefits, Costs, and Design Considerations of a Central Bank Digital Currency
The Fed defines a CBDC as a digital liability of a central bank that is widely available to the public. It is analogous to a digital form of paper money.
The Fed’s adoption of a CBDC would be a fundamental change for the US payments system.
A CBDC would fundamentally change the private sector’s role as an intermediary in the creation and distribution of credit and would place more responsibility within the central bank. Although a CBDC could reduce some sources of financial instability, it would fundamentally alter the structure of the banking system and create new risks.
- The Fed suggests that a major benefit of offering the public broad access to a CBDC is that doing so would introduce into the system digital money that is free of credit and liquidity risk. A CBDC has the potential to streamline cross-border payments by using new technologies, introducing simplified distribution channels, and creating additional opportunities for cross-jurisdictional collaboration and interoperability.
-> Debate: such benefits do not depend on the Fed offering a CBDC to the public. Faster and more easily executed payments have come from the private sector. Venmo, Square, and Stripe are examples of innovative providers that have disrupted current legacy systems and greatly improved the payments system without government support.
-> Debate: although it is true that a CBDC would be free of credit and liquidity risks, this benefit is overstated.
- First, it is unclear whether the actual difference in credit and liquidity risk between a CBDC and private options, such as private coins backed by safe assets or commercial bank money with FDIC insurance, is sufficiently compelling to justify a CBDC
- Second, there are policy options that can reduce liquidity and credit risks for payments that do not involve issuing a CBDC. For example, such risks can also be avoided by providing 100 percent FDIC insurance on bank deposits
- The introduction of a dollar-denominated CBDC would strengthen or better assure the United States’ role as the issuer of the world’s reserve currency.
-> Debate: having a CBDC is neither necessary nor sufficient for any currency to be a reserve currency. A durable reserve currency requires an economic system that is not only well developed but operates under a clear rule of law and allows for the free flow of capital. The US financial system has these attributes and is among the most reliable means for international settlements, which are also transacted in digital form. Introducing a CBDC would have little effect on these attributes. What has become more critical to the United States’ national and international role in payments is the need to settle in real time, which it is developing through its FedNow initiative.
- A possible additional benefit of a CBDC is providing unbanked individuals access to the payment system. Unbanked individuals are often reluctant to use banks over their concerns about high fees and over their general distrust of banks. Thus, the idea of a safe central bank digital account, in the form of a CBDC, with modest or no fees and ease of access, is appealing to those who wish to eliminate any vestiges of an unbanked group.
-> Debate: Making a CBDC available to the public and businesses would certainly also make it available to unbanked individuals. However, the logistics of offering a CBDC directly, through banks, or as some suggest, through the local post office, would be a significant challenge to all parties involved. Providing a subsidy to assure free access to a CBDC and related banking services to the 7.1 million unbanked households—as distinct from the broader banking public—would be difficult to accomplish and would likely be controversial. Doing so would also raise the question of whether a large enough portion of the unbanked public would join such a system to make the system worth the cost. In addition to distrusting banks, many unbanked individuals similarly distrust the Fed and the federal government. Thus, although serving unbanked individuals is a worthy goal, it carries a heavy cost, given the benefit for unbanked households that might be reluctant to use it.
The potential disruptive effect a CBDC would have on the banking industry’s structure and on financial stability. The Fed’s issuance of CBDC accounts would substantially disrupt the commercial banking industry’s role as an intermediary within the US economic system. The introduction of a CBDC would invite a shift of money out of bank deposits into direct central bank deposits, reducing bank deposits as a source of funds for the industry and likely affecting the relative cost of credit across the economy.
If the Fed were to become the central depository of private-sector deposits through its CBDC, public pressure would almost certainly build for its mandate being expanded to providing credit to the public, corporations, and consumers. Credit allocation would become increasingly centrally controlled and politicized. It would involve a massive expansion of central bank operations and power, undermining private institutions’ role as intermediaries between depositors and borrowers.
The Right to Privacy in Payments
Fed CBDC accounts could provide the government with unprecedented access to individual financial transaction data, a risk that introduces significant privacy issues into the discussion.
The introduction of a CBDC might affect the efficacy of monetary policy. Its introduction would affect the role of bank reserves and how interest rates are set.