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In laying out a case for how a U.S. central bank digital currency (CBDC) could improve financial stability, the Federal Reserve chief poses questions that will be on every central banker’s mind.
U.S. central bank governor Lael Brainard has given a cautious assessment as to whether there is a role for a U.S. CBDC in the digital payments space, its cost, benefits and overall properties of that CBDC.
In a speech entitled "Preparing for the Financial System of the Future", Brainard made arguments both for and against the implementation of a digital dollar.
In favor was the consideration for how to preserve “ready public access to government-issued, risk-free currency in the digital financial system,” which according to her, referencing a recent Bank of International Settlements report, could be the safest form of money.
Raising the stakes, Brainard asked people to consider a future world where other major foreign currencies had issued CBDCs and whether the strength and importance of the dollar would be a benefit or a detriment to this world.
Brainard, however, warned that “any consideration of a CBDC must include a robust evaluation of its impact on the stability of the financial system — not only as it exists today but also as it may evolve in the future.”
Innovation and growth was also an issue, with Brainard keen to continue promoting “responsible innovation” and for a CBDC to complement “private sector innovations transforming the financial landscape of the future.”
To that extent, she endorsed one of the four design principles of a CBDC, intermediation, laid out in a recent Federal Reserve analysis report that it should stick to the issuing and settlement of the digital dollar, while private sector firms interfaced directly with consumers.
Brainard also acknowledged fears among banks that by making a digital dollar too safe and attractive for consumers, investors and foreign governments, a CBDC could run the risk of putting stress on financial intermediaries at the worst possible time.
Putting interest on a CBDC account could not only cause a run on the banks, but it could lead to suboptimal investment in mortgages and the economy more generally by banks who would be starved of funds. For this reason, she proposed limits such as “offering a non-interest bearing CBDC and limiting the amount of CBDC an end user could hold or transfer.”
On the flip side, others have noted that by limiting the functionality of a CBDC to be worse than that of bank deposits, including limited transactability of one CBDC with another, this could potentially allow the re-emergence of money and exchange controls by the back door. Unlike cash which is easy to exchange, central banks would have considerably more control where funds go, being able to limit who has the right to pay who and entirely prevent exchange with a CBDC of a country it did not like.
Additionally, not all central banks are considering putting such limits on their CBDC. The Sweden central bank has not ruled out interest-bearing accounts, which if implemented could theoretically incentivise people to exchange their digital dollars, RMB and pounds to e-krona during a recession. Central banks could either decide to accept competition in the CBDC market and compete on a level playing field, or they could restrict transactions with both outcomes potentially generating problems.
Many of the concerns brought up by Brainard mirror that of a recent UK House of Lords report which asked the question whether a CBDC was a solution in search of a problem? The mostly critical report concluded that a CBDC “could present significant challenges for financial stability and the protection of privacy” and that there were formidable barriers to making national CBDCs interoperable.
Learning to live with Bitcoin
Unlike central bankers of other countries such as India, where crypto has been labelled a ponzi scheme, Brainard was far more conciliatory, speaking of stablecoins potentially becoming “commonly used for everyday transactions, both domestic and cross-border.” For her, making sure a strong regulatory framework for risk management, governance and settlement is the pragmatic thing to do. Brainard even went as far to say “the coexistence of CBDC alongside stablecoins and commercial bank money could prove complementary.”
Although these statements are hypotheticals, with neither Brainard nor the Federal Reserve analysis report drawing any major conclusions on whether to implement a CBDC, the lack of a firm stance shows the Federal Reserve is being more cautious than countries such as China or Nigeria, which have already launched their CBDC. As with the House of Lords report, they recognise the debate is far more complex than CBDC good, Bitcoin bad. They are likely to continue to be cautious until the situation evolves and becomes much clearer.
