A central bank digital currency is not a good idea, redux

The introduction of a central bank digital currency (CBDC) allows the central bank to engage in large-scale intermediation by competing with private financial intermediaries for deposits. Yet, since a central bank is not an investment expert, it cannot invest in long-term projects itself, but relies on investment banks to do so. We derive an equivalence result that shows that absent a banking panic, the set of allocations achieved with private financial intermediation will also be achieved with a CBDC. During a panic, however, we show that the rigidity of the central bank’s contract with the investment banks has the capacity to deter runs. Thus, the central bank is more stable than the commercial banking sector. Depositors internalize this feature ex-ante, and the central bank arises as a deposit monopolist, attracting all deposits away from the commercial banking sector. This monopoly might endangered maturity transformation.

Here is the NBER working paper by Jesús Fernández-Villaverde, Daniel Sanches, Linda Schilling, and Harald Uhlig.  Here is my earlier Bloomberg column with similar themes.


Is the CBDC [ or whatever] denominated in local currency, or is it a different currency? If the former, nothing matters. If the latter, will this be under a fixed rate regime or a floating rate regime?

Is there any additional substance to the question?

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It's not a good idea because career bureaucrats steeped heavily in "conventional wisdom" are not able to innovate or at least improvise a good response in the face of a quickly changing landscape. They also lack the technical competency to assess blockchain design and implementation and lack the operational competency to run, deploy, maintain, and keep secure the whole enterprise. It is completely different skillset. Also, the private sector can strike out while swing for the fences but central bankers have little room for experimentation and really need to play a game of safe and steady singles.

It would be pure insanity. I do think they should possibly be the authority in defining the standards and helping to ensure an orderly market - such matters need legal rigor. If currency is in effect a representation of a book of collateralized assets value that has been mobilised (issued) it is critical that the quantum and terms of issuance that circulates represents the credit markets net appetite for risk. The market (assuming very few bad actors) is best placed to determine money supply. Having bureaucrats involved will end badly. In my view central banks, and their proxies, should never never engage in market operations - to do so denies and blinds the market of its risk assessment mechanism and creates a dangerous precedent with political pressure and risk..the "do whatever it takes" moments. If you have any doubts simply look at the ponzi schemes that are the equity and bond markets we currently enjoy. Italian 10 year bond yields are 0.91%, the us is 1.47% - total and utter nonsense!

Google Tyler Cowen + Judy Shelton = crickets

So why wouldn't the Central Bank itself do the maturity transformation?

But on the other hand if it does it's job and prevents Pl and unemployment (all resources, not just labor) (or NGDP) from straying from target what's the point of the CB making itself into the main deposit-taking, term intermediate institution?

During a panic, however, we show that the rigidity of the central bank’s contract with the investment banks has the capacity to deter runs.

In a free market, one where there is no obsession with guaranteeing the solvency of failed banks, these bad banks are allowed to disappear, just as failed building contractors, manufacturers, saloons and harmonica dealers pass from existence. A "panic" is the mechanism for this in the banking business. Central banks set the "price of money", an example of central planning that hasn't worked in any other context. Why should it be a failure in determining the price of oil or other commodities but just the right answer for money?

This is also about interest paid by the Fed on bank reserves at a rate far higher than what banks pay on deposits, savings accounts, and money market accounts. Why should banks but not others have the benefit of higher than market rate interest on the banks' deposits with the Fed? Indeed, why should the Fed pay any interest on bank reserves? Here's Scott Sumner explaining how the Fed implements monetary policy by changing the demand for money by adjusting the interest rate paid on reserves (before interest on reserves, the Fed implemented monetary policy by changing the supply of money): https://www.mercatus.org/publications/monetary-policy/should-fed-pay-interest-bank-reserves Now consider the consequence if anybody could make deposits with the Fed and receive a higher than market interest rate on the deposits. Talk about having a tight grip on the demand for money. Would that be a good thing or a bad thing? Fed detractors would say it's a terrible thing.

The Fed's current interest rate on reserves (required and excess) is 1.6%. There are money market accounts and even FDIC-insured savings account that pay more than this and are available to the general public (check www.bankrate.com to confirm). The Fed's payment of interest on reserves is not a benefit -- it is rather the removal of an implicit tax that existed before, since banks are required rather than merely invited to hold deposits at the Fed.

Isn't the Fed to some extent in the business of maturity transformation with its QE program?

Banks still remember the S&L crisis. Maturity transformation (short deposits, long loans) in an era of rising interest rates gets you crushed.

I don't think we're in an era of rising interest rates, so as a taxpayer, it seems like the Fed has made a tidy profit to date in its role as maturity transformer, but right now, they are paying 1.6% on excess reserves and the 30-year Treasury yield is 2%, so there's not a lot of daylight there and taxpayer risk is higher than when IOER was 0.25% and long-term rates were north of 3%.

To me, this is an obvious argument for cutting the IOER rate yesterday.

As of right this minute, the yield on the 30-year Treasury is 1.896%. It's never been that low before. 10-year is 1.458%.

As a taxpayer, I'm left to wonder why the Fed would choose to engage in short-term borrowing with banks at a 1.60% rate when the market is offering more attractive alternatives.

As a taxpayer, I'm wondering why governments can't find useful things to invest in at 1.89% discount rate. maybe even the 2nd Ave subway line makes sense at that rate.

I'm not sure what the problem is. The Fed borrows at 1.6% and holds literally trillions of dollars of government securities that yield more than 1.6%. Of course, it effectively borrows at 0% when the banks choose to withdraw some of their reserves and ask the Fed to deliver cash.

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