Tuesday, March 12, 2024

Money Developments (5a) Central Bank Digital Currencies

Many central banks are worried that changes in the use of money will make it more difficult for them to control the money supply in their nation. In response to these developments, they are establishing central bank digital currencies (CBDC).

Most CBDCs will be established by allowing people and businesses to open an account at the central bank (for example, the Reserve Bank of New Zealand here, or the Bank of England in the UK). People could get their wages or salary paid into this account. Using a digital wallet of some kind, they can also use the digital currency to make or receive payments when buying or selling, in the same way as they now use debit or credit cards.

The digital wallet could be an electronic card or other portable token, but these would not be very secure. Most people and businesses would be more likely to use an app on a smartphone to make economic transactions with money in their digital account at the central bank of their nation. They mostly know how to keep their phones secure, so this should be safe.

At this stage, it is unclear how great the demand for central bank digital currencies will be. From what I have read, the experts in the central banks developing these currencies are not sure that people and businesses will use the digital currency they create. Many will prefer to continue using the payment services and bank accounts provided by their existing retail bank. There might be a lack of trust in a service provided by the government. (I note from the discussion papers issued by the Reserve Bank of New Zealand that they don’t seem to be very enthusiastic about a CBDC. They seem to be uncertain if there would be widespread take-up).

Some nations are establishing a CBDC to facilitate international transactions for people who are travelling, or businesses trading with businesses in other countries. If a CBDC makes international transactions simpler and cheaper than the service offered by existing banks and credit card companies, they are more likely to switch to using it.

CBDCs are the fastest and easiest way for nations wanting to use their own currencies when conducting international trade to operate currency swaps. These swaps will become more important because they eliminate the need to hold reserves of currencies that a nation uses for trade.

Payment Service Only
Most central banks seem to be planning to limit their CBDC offering to a payments service. They are not planning to provide all the other services that are typically offered by retail banks. The transactions account they are offering will be like a cheque account that does not pay interest, but can be used to make payments to other people and businesses. Most central banks do not intend to get into competition with retail banks by offering to pay interest on deposits. If they offered interest returns that are greater than those offered by retail banks, the flow of money into the CBDC would increase significantly.

Most of the accounts at the central bank will not provide overdrafts, mortgage-based loans, business loans, seasonal finance or insurance services. This means that most people and businesses will have to maintain their relationship with their existing retail bank. That would change dramatically if the central bank offered loans that are cheaper and easier to access than those offered by retail banks.

If there is uncertainty about the stability of a retail bank, causing depositors to fear a bank run, they might believe that their money is safer as a CBDC in their account at the central bank. However, if the government is guaranteeing deposits in the retail banks, then this advantage might not exist.

I will look at the problems with CBDCs in my next post

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