Cash & Liquidity ManagementLiquidityCBDC ‘need not undermine financial stability’

CBDC 'need not undermine financial stability'

A value-based wholesale CBDC would replace or complement reserves at the Central Bank with a restricted access digital token

The introduction of a Central Bank Digital Currency (CBDC) need not undermine financial stability, according to a working paper from the National Bureau of Economic Research (NBER).

The paper, titled ‘On the Equivalence of Private and Public Money’ and authored by Markus Brunnermeier, Department of Economics, Princeton University and Dirk Niepelt, Neues Schloss, Study Center Gerzensee, claims that a generic framework that nests many—and most standard—models of money, liquidity, and financial frictions is the way forward.

The paper highlights that: “A transfer of funds from deposit to CBDC accounts would give rise to an automatic substitution of one type of bank funding (deposits) by another one (central bank funding)—the issuance of CBDC would simply render the central bank’s implicit lender-of-last-resort guarantee explicit. By construction, a swap of CBDC for deposits thus would not reduce bank funding; it would only change the composition of
bank funding.”

With structural change occuring against the background of tightening regulation and governments discouraging cash transactions in order to fight tax evasion and money laundering, central banks or private entities should be the principal issuers of (digital) money has been the subject of a long-standing debate.

Swap of monies leaves the system unchanged

The model considers factors like liquidity and value, equivalence, wealth neutrality and liquidity neutrality, as well as a consolidated government sector for justifying that swap of monies leaves the equilibrium allocation and price system unchanged.

The paper states that: “CBDC would have the same liquidity properties as deposits and a swap therefore would be liquidity neutral. Moreover, the payoff characteristics of CBDC would likely match those of a portfolio of existing securities such that the asset span would remain unchanged.

“In addition, CBDC and pass-through funding would bestow the central bank with an informational advantage relative to conventional runs into cash, which the central bank only learns about with a delay.”

The paper makes the following four contributions:

  1. First, it provides a general framework for the analysis of monetary economies.
  2. Second, it derives an asset pricing condition that relates the liquidity of securities to their bubble component and the seignorage rents their issuers reap.
  3. Third, it provides sufficient conditions for the equivalence of monetary systems.
  4. Finally, it applies the findings in the context of several examples.

It concludes as: “Whether a non-neutral monetary reform would be toward the better or the worse is a question that the equivalence result cannot address. An answer to this question requires an explicit characterization of equilibrium in a particular model. For policy discussions about monetary reform, our paper therefore does not propose definite answers, but an analytical framework and robust road map.”

Wholesale CBDC the way forward

Meanwhile, Vitas Vasiliauskas, a member of the Governing Council of the ECB and chairman of the board of the Bank of Lithuania, has spoken in favour of wholesale central bank digital currencies.

Speaking at a conference in the US, Vasiliauskas weighed up the pros and cons of retail or wholesale CBDCs, ultimately coming out in favour of the wholesale model meant for the institutional clients.

Vasiliauskas said: “A value-based wholesale CBDC would replace or complement reserves at the Central Bank with a restricted access digital token. A token would be a bearer asset, meaning that during the transition the sender would transfer value to the receiver without intermediaries. This is something fundamentally different from the current system in which the Central Banks credits and debits the accounts without transferring actual values.”

He added that there are many alternatives available in the market which questions the cost-effectiveness of retail CBDC. Using the example of Bank of Lithuania, he said that it already provides a payment infrastructure called Centrolink, which supports 24/7 “instant payments”. “Such products limit the scope and value of retail CBDC,” he added.

“Therefore, assessing the balance between risks and benefits from the perspective of generally conservative central banks, the wholesale CBDC seems like a more viable option going forward.

“The Riksbank in Sweden seems to be the closest to actually issuing a CBDC, the so-called e-Krona. The bank has been working on it since early 2017, and a possible pilot program is in the pipeline. The underpinning argument is that the state needs to maintain the role in the payment system, considering the trend of dramatically declining cash use in the country,” he concluded.

Earlier this month, European Central Bank (ECB) President, Mario Draghi, had claimed that cryptocurrencies are assets and not currencies when recently questioned about his stance on Bitcoin – and that there are no plans for a centralised euro-based digital currency.

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