Central bank digital currencies (CBDC) and the need for public debate
As we prepare to welcome Naga Munchetty to the festival to discuss digital currency with Sir Jon Cunliffe, Bank of England, and Tom Duff Gordon, Coinbase, we asked Professor Jamie Morgan of Leeds Beckett University about the possibility of a debate on the topic.
According to the Law of Techno-Geek Proportionality, for every million times a nerd gets excited about “the latest thing” the world might change once. Central bank digital currency (CBDC) may be that once. There is nothing new about digital money, but there may be many profoundly new things about CBDC. This is especially so for “retail” CBDC. At the moment, the vast majority of money in existence takes the form of deposits at Santander, Barclays, and other commercial banks. As the Bank of England makes clear, most of this is originally produced when a bank extends a loan and creates a sum as a deposit which the borrower can then spend. This money flows around our payments system and the money supply, albeit there is more to money supply than just this, grows as cumulative debt grows and shrinks as debt is paid down. Though we rarely think about it, since the money is denominated in £s and the central bank essentially guarantees that it will exchange at par for central bank money, most of what we think of as money is really Santander or Barclays etc credit units. Retail CBDC could change this state of affairs.
Currently, central bank money exists in two forms, cash in circulation and the reserve accounts that banks must hold at the central bank and which they are required to use to settle the balances between themselves as payments flow between accounts in one bank and another. Retail CBDC, however, gives the public access to digital central bank money and conversely gives the central bank (and, in principle, government) a new and immediate way to put money into and influence the nature of society and economy. Banks go to a lot of trouble to convey an image of themselves as a vital utility providing an essential service to the public. But behind this sits a small group of private companies to which has been delegated an astonishing degree of power and on whom we are dependent. Potentially, retail CBDC reduces that power and reconfigures dependency within the public-private axis of money…
“We’ve mentioned trust and in a complex finance system, trust is not an abstract concept. Much depends on the projection of competence, credibility and authority. In the modern world, we are increasingly aware of limits on these”Professor Jamie Morgan lectures in the Subject Area of Economics, Analytics and International Business
I say potentially because a great deal depends on purpose, implementation and policy. It is also important to note that CBDC is a catch-all term for different possible designs and use of technology. In general, CBDC (and if the following terms are meaningless to you it doesn’t really matter for understanding what CBDC can do) makes use of the same distributed ledger, blockchain, cryptographic and smart contract technology as cryptocurrency. The main difference is that these are maintained and controlled by a central authority (the central bank). All the other advantages of the technologies remain: secure, rapid, recorded and immutable transactions without the need for a confirming intermediary. A retail CBDC may also be token based (the central bank issues digital pound tokens into a digital wallet that the public carry around with them on a device and can spend) or account based (the central bank requires the public to maintain an account from which payments are verified), interest bearing or non-interest bearing. Finally, the central bank can opt to offer direct access to CBDC from the central bank or choose some variation where the underlying infrastructure is provided by the central bank but the overlaid payments interface is provided by others through additional or existing systems.
Almost every country in the world is at some stage in developing and implementing a CBDC. Since you are reading this you are likely aware that the Bank of England published a discussion paper on CBDC in March 2020, a further discussion paper in June 2021 focused on the role of new types of digital money and their impacts (notably a variant on cryptocurrency called stablecoin and the motives this might give for creation of a CBDC) and a consultation paper in February 2023, accompanied by a supporting working paper on the technology. In a speech given at the time of this latest publication Deputy Governor of the Bank, Sir Jon Cunliffe clearly states that (according to the Bank of England’s assessment) a digital pound will be needed for everyday payments and the Bank has embarked on detailed policy and technical development which may take around two to three years…
There are various potentials that provide reasons to adopt or reject CBDC for domestic use (there is a whole other debate for its international implications). Perhaps the easiest to grasp is typically posed using that catch-all term from economic jargon “efficiency”. While we all understand that borrowing money invites fees and interest charges, we still tend to think of money as something we pay with rather than something we pay for. Yet the creation of money, production and maintenance of money delivery, payment and processing systems all involve costs and fees. Sometimes we are aware of these and sometimes not. For example, transport and storage of money and maintenance of ATM’s and the network that underpins these is a massive hidden expense. Every payment system involves some underpinning infrastructure and existent payment services involve intermediaries, each charging fees. Fundamentally, the current banking system puts the majority of our income and most of our financial activity in the hands of private banks. CBDC could provide an alternative that eliminates the need for much of this intermediation, its costs and fees. Less radically, a CBDC might introduce diversity and competition for commercial banks as they currently exist.
In any case, the Bank of England currently faces a conundrum. In the present system, cash represents a visible marker of money. It reminds the public that the state stands behind the value of money. Put another way, cash provides an important symbolic “anchor” which helps to maintain trust in money. In an increasingly cashless society with ever more diverse digital payment options, this role is under threat. While the Bank of England is clear that it does not envision CBDC as a substitute for cash in the near future, the development of a CBDC is, at least in part, an acknowledgement of the direction of travel technology of money seems to be taking. It also provides an important opportunity, if a suitable delivery system can be developed, to provide money to unbanked and/or cash-dependent people. This could both enhance financial inclusion and, given the potential of CBDC, lead to the replacement of cash with a digital variant less conducive to tax evasion, fraud and criminality.
We’ve mentioned trust and in a complex finance system, trust is not an abstract concept. Much depends on the projection of competence, credibility and authority. In the modern world, we are increasingly aware of limits on these. CBDC provides multiple opportunities for a central bank to improve its control, respond to problems and forestall crisis. A successful CBDC could reduce the attraction of cryptocurrencies as means of payment (though not as speculative assets) and thus prevent the future loss of control of money supply that these threaten. CBDC might also significantly enhance monetary policy. A widely adopted and used CBDC could provide a new means to directly and more or less immediately increase or decrease the money supply, target specific economic sectors or socio-economic groups and influence commercial interest rates, as well as payments systems activity. Again, none of this need depends on the cooperation of commercial banks and could, even if used conservatively provide a mechanism to encourage compliance from commercial banks.
For commercial banks there are reasons to be concerned regarding disruption to the status quo. Not only might they lose some proportion of their business, “disintermediation” may also cause balance sheet shrinkage and increase the funding costs associated with its loans. The problem is more obvious with cryptocurrencies rather than CBDC: a payment from a bank account transfers to a digital wallet and so the bank loses this sum from a customer account but also an equivalent sum from its reserve account at the central bank. Since people will still have a need to borrow and the bank still wants to lend (as a profit-making entity), insofar as it maintains its lending, the bank will need to acquire more reserves (at some cost to itself). CBDC adds an additional complexity insofar as if there is loss of trust in a bank, unless prevented somehow, customers will have the capacity to transfer into CBDC at the stroke of a key – from which an accelerated digital run on a bank could occur. This possibility, of course, invokes the spectre of financial crisis. From the point of view of the central bank, however, CBDC could also provide a way to directly inject money into the economy. This might forestall an incipient crisis focused on the commercial banks, preventing an initial disruption or panic becoming a more widespread economically damaging financial crisis, while also allowing the central bank to guarantee the integrity of payments in the economy. So far though, and despite stating it has no intention of introducing a CBDC in a format that artificially preserves the status quo and impedes competition, the Bank of England seems to favour a form of CBDC that operates via other platforms, limits holdings and pays no interest…
There is a lot more we could say here but it should be clear that a CBDC allows a central bank to take on new powers (in the “capacity to do” sense), to take back power (in terms of “scope to be the decisive actor in a system” sense), but also to perhaps acquire excessive power (in the “who gets to decide” sense). These last two depend very much on perspective, accountability and an age old debate regarding the legitimate role of the state and the scope for democratisation of its institutions. With this in mind, there is a final feature of the technology that underpins new forms of digital money, including, in principle, CBDC that warrants a mention, and that is programmability. We have become used to thinking of money as a universal, anonymous means of getting what we want, but a programmable money can be both time limited and purposed. As such, a CBDC could become a means to support local economic activity, finance investment, ensure automatic payment of tax at point of transaction, achieve social welfare goals and enforce carbon budgets. Depending on your point of view this is enlightened public policy in action or sinister social engineering. In any case, programmable money allows for progressive policy agendas, but equally for new forms of rationing and discrimination.
To conclude, it is worth reminding ourselves that one of the original justifications for cryptocurrency was a deep scepticism regarding the motives of both corporations (“the banks”) and the state (insofar as the state is “captured” by financial interests). For a libertarian, the spectre of a central bank asserting greater control over money removes the main attraction that the technology originally offered (peer-to-peer decentralized activity). For more mainstream voices, a poorly constrained CBDC may undermine the independence of the Bank of England and provide a new set of tools that encourage greater intervention on behalf of the government of the day. From still another perspective, CBDC offers scope to democratise finance and provide a public alternative that breaks the power of the banks. From this last point of view, the main barrier to enlightened use of CBDC is a narrow central bank technocracy, hampered by insufficient imagination and unwilling to grasp the potentials CBDC offers. There is, therefore, much to discuss and great need for deliberation….
Join our conversation on the subject on the 30th September at 3pm HERE
Jamie Morgan is professor of economics, Leeds Business School, Leeds Beckett University. He is the author of: