LONDON – In recent years, central bank digital currencies (CBDCs) have become an increasingly hot topic for debate among economists, regulators, and financial and business commentators. But the primary case for the technology is not economic or financial; it is political. In a rapidly digitalizing world, central banks are staring down a future in which they may lack the tools necessary to manage crises, and in which they may no longer be able to protect their monetary sovereignty.
Understood in this context, a CBDC is not just a mechanism for enhancing the payments system, but also a crucial weapon in the fight for the “soul” of the monetary and financial system, and for the macroeconomic stability that it provides. Without their own toolkits for the digital age, central banks will not be able to maintain their monopoly over money creation, and their governments may be eclipsed geopolitically.
A full accounting will show that the benefits of CBDCs outweigh their costs and risks, so long as safeguards against privacy violations and government overreach are introduced from the outset. Recognizing this, most central banks around the world are now considering their options and studying potential design features; some have already rolled out CBDCs.
But whether a country develops a CBDC is not a matter for central banks to decide by themselves. Given the political implications (both nationally and globally), designing CBDCs requires material involvement by governments and parliaments. As policymakers consider their options, they should recognize that doing nothing is itself a consequential decision. Governments that fail to keep up with technological trends will find themselves increasingly at the mercy of forces they cannot control.
Why CBDCs?
CBDCs are usually portrayed as a tool for improving cross-country payment systems, fostering financial inclusion, and – in some countries – providing a substitute for diminishing cash. But while important, these benefits are not the main reason to create a CBDC. What really matters are the effects of the digital revolution on fundamental questions of political economy. The concept of money itself is at stake.
From the perspective of political economy, there are three main reasons to introduce a CBDC. First, a CBDC can lend support to monetary sovereignty and a central bank’s capacity to deliver on its mandate. Central banks exist to provide a public good: monetary and financial stability. In an increasingly digitalized world, argues Benoît Cœuré, a former European Central Bank board member, the authorities will need digital forms of their national currencies to prevent key monetary-policy transmission channels from being supplanted by private forms of digital money. Already, the proliferation of cryptocurrencies and digital assets in recent years has challenged central banks’ monopoly on money creation, despite all the recent volatility in private digital currencies. And yet, intervening to stop potentially worthwhile private-sector efforts could seriously harm innovation.
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Second, CBDCs can drive more efficient policymaking. As former Citibank Chief Economist Willem H. Buiter recently noted, retail CBDCs can help fine-tune monetary and fiscal policies to address specific conditions and contingencies, owing to their unlimited digital programmability. Policymakers thus could avail themselves of far more effective crisis-management tools compared to what they currently have at their disposal.
CBDCs also would provide domestic capital markets with their safest possible digital asset, owing to the lack of any credit or liquidity risks (other than those stemming from the issuing country’s sovereign risk). They would also make costly deposit insurance for commercial banks redundant.
This last benefit has been underscored by the recent bank failures in the United States. In the case of Silicon Valley Bank and the mid-size banks that followed in its wake, the US Federal Reserve and the Treasury stepped in to guarantee even those deposits above the statutory $250,000 threshold, thus creating an implicit backstop for all deposits at all banks nationwide. In doing so, Martin Sandbu of the Financial Times observed, they have already instituted one major component of a CBDC.
Finally, changing geopolitical factors have increasingly bolstered the case for CBDCs, at least from the perspective of major powers such as the US, China, and the European Union. The competition for reserve-currency status – or what some commentators have called a “digital currency arms race” – among globally systemic central banks has only intensified as a result of Russia’s war in Ukraine and the escalating Sino-American rivalry.
Accordingly, in a seminal 2022 report, the Fed found that the third most important benefit of a digital greenback would be to “preserve the dominant international role of the dollar.” And the ECB, for its part, has been even more straightforward on this point, concluding that the first objective of a digital euro would be to help Europe achieve strategic independence (whereas fostering an international role for the euro ranks fifth).
Finally, while the People’s Bank of China does not publicly acknowledge any geopolitical reasons for creating its pilot CBDC, the e-CNY, such motives have obviously underpinned its efforts to support dollar-free cross-border payments, including under the auspices of the Belt and Road Initiative.
CBDCs can support a currency’s international role in several ways. Because they will allow for faster, cheaper international invoicing, they could crowd out traditional currencies that have not gone digital. They also can aid superpowers’ quest for dominance in digital-finance infrastructure and technology, yielding positive innovation spillovers to their economies. And, as mentioned above, a country that fails to adopt a CBDC would weaken its own domestic monetary sovereignty and effectiveness, thereby undermining the credibility and the potential reserve-currency status of its currency.
The Counterargument
Of course, there are weighty arguments against CBDCs. One major fear is that they threaten the prevailing commercial-banking business model and thus jeopardize financial stability. According to this argument, CBDCs may create unfair competition for deposits with traditional deposit-taking institutions and other low-interest-bearing safe assets such as Treasury bonds. As last year’s Fed report put it: “A CBDC could fundamentally change the structure of the US financial system, altering the roles and responsibilities of the private sector and the central bank.”
More recently, the Fed’s communication appears to have hardened in this regard. In April, Michelle W. Bowman, a member of the central bank’s Board of Governors, offered a rather apocalyptic assessment of the potential for disruption: “There are significant risks in adopting a CBDC that cannibalizes rather than complements the US banking system.”
This objection is surmountable with appropriate design features. As a Bank for International Settlements study and many other central-bank analyses have suggested, such features might include limitations on a CBDC’s scope of use, as well as “hybrid” or “intermediated” models whereby commercial banks provide the interface (such as digital wallets) through which customers access CBDCs and other banking services. But the real competitive threat to banks comes from other sources, such as non-bank financial institutions and, most importantly, Big Tech.
Objections to CBDCs on privacy grounds are also valid. Owing to digitalization, vast amounts of data on firms and individuals are being hoovered up every day. But, so far, this has been done primarily by the private sector.
By contrast, a CBDC could potentially allow political authorities to monitor people by keeping tabs on all their consumer and financial activities. There is a big difference between a corporation violating your privacy and the state doing so. Moreover, a malign government could abuse the centralized nature of CBDCs in all manner of ways, such as by freezing the accounts of opposition parties and leaders.
Equally important, CBDCs may create more political pressure for direct central-bank lending, particularly in this populist age. Once there is a significant stock of consumer deposits at a central bank, politicians may see a piggy bank that is just waiting to be broken open to finance their pet projects.
But, again, such risks can be managed. A CBDC would need to be accompanied by strong privacy and due-process protections as well as an upfront, forceful prohibition against inappropriate central-bank lending activity (at least outside of major crises such as a war or pandemic).
The New Reality
To date, only ten small countries in the Caribbean and Nigeria have fully rolled out a CBDC. All are emerging-market economies with relatively less institutional credibility than one finds in Europe or the US. As such, local demand for their CBDCs has been limited.
Like traditional forms of national fiat currency, a CBDC is only as credible as the central bank and government behind it. Nonetheless, these early cases confirm that CBDCs are no longer just an academic idea. They have become real-world political projects, and many of the technical discussions about CBDC modalities and design options are already largely over.
Looking ahead, governments around the world will increasingly be engaging with digital money. In the United Kingdom, the Treasury and the Bank of England are now jointly overseeing a CBDC project known as “Britcoin.”
In several other countries, such as Sweden, national parliaments are getting involved. And in the US, Fed Chair Jerome Powell has said repeatedly that a retail dollar CBDC would require congressional approval (though a less transformative wholesale digital dollar might not). Whatever the institutional underpinnings, decisions about sovereign money are fundamentally political.
Central banks and their governments thus find themselves at a crossroads. In deciding whether to introduce a digital currency, they should start with the observation that digitalization is accelerating and will continue to do so, with or without them. Viewed as a matter of political economy, the risks of eschewing CBDCs clearly outweigh the risks of adopting them, provided that they come with the right preconditions and safeguards.
These must be in place from the outset. They include a prohibition against central-bank direct lending outside of major crises; strong privacy protections; and additional mechanisms for holding a potentially more intrusive central bank accountable. Moreover, regulators could continue to allow the use of private digital assets that offer greater privacy protections.
Decision Time
What would a future digital financial system look like with or without CBDCs? The differences between the two scenarios are stark.
In a world with CBDCs, central banks would retain and strengthen their monetary sovereignty and monetary-policy effectiveness, because they would have better tools for addressing the frequent stresses that emerge from modern, globally integrated monetary systems. Crisis management would become faster, more targeted, and more efficient.
Meanwhile, commercial banks would retain a large share of their deposit-taking business and all lending activity, only now they would be part of the “intermediated” CBDC model, representing the know-your-customer interface between the central bank and economic agents. Striking the right balance will require new governance structures and mechanisms for ensuring accountability and proper oversight.
Traditional central-bank cash would remain in place for the sake of continuity, and private digital assets such as Bitcoin would be regulated only to enforce anti-money-laundering measures and to combat the financing of terrorism. There would be no reason for governments to provide a backstop for private digital assets.
Without CBDCs, central banks would avoid becoming a perceived threat to the current status quo (with respect to privacy and the current commercial-banking model), but they would lose some or even most of their monetary sovereignty and policy effectiveness. However, if history is any guide, bolder, less regulated private sectors would inevitably generate more frequent financial-sector stresses, which in turn would necessitate public-sector interventions.
In this scenario, central banks and governments might lack the tools to address the problem in a timely and efficient manner. In the absence of CBDCs, it could be only a matter of time before we suffer a repeat of the COVID crisis, with its massive, un-targeted interventions. The future would most likely bring more inflation, more debt, and more disruption than is politically sustainable.
