Wednesday, December 23, 2020


I wrote an oped for Il Sole 24 Ore on central bank digital currency, as part of a series they are doing. It's here in their premium edition (gated) here on their blog, in Italian on top and English below. Thanks much to Luciano Somoza and Tammaro Terracciano for translation and inspiring the project.


A central bank digital currency (CBDC) is in principle a very good idea. It offers the possibility of very low-cost transactions to households and businesses, especially in securities and international transactions. More excitingly, CBDC offers us a foundation for an efficient and nimble financial system that is completely insulated from recurrent crises. 

But CBDC poses a puzzle, as it undercuts many of governments’ and central banks other questionable objectives. Central banks want to prop up conventional banks, who benefit from taking deposits. And governments are unlikely to want to allow the anonymity that is the great attribute of physical cash. 

One vision for CBDC basically gives everyone access to bank reserves. Reserves are interest-paying accounts that banks hold at the central bank. When bank A wishes to pay bank B, it notifies the central bank, which just changes the numbers in each account on the central bank’s computer. The transaction can be accomplished in milliseconds, and costs basically nothing. Why don’t we have that? We should.

Now, opening reserves to everybody, is not a practical idea. Central banks have no competence at the daily details of interfacing with millions of consumer accounts. If you lose your password, if you made a payment by mistake, if you overdraw your account, do you think the ECB  will answer the telephone, or even run a smooth website? Can central banks even begin to effectively implement their own regulations for consumer-facing financial services? Probably not. 

Thus, a practical CBDC really will likely be limited to a wide array of non-bank financial institutions, who then handle the consumer-facing details, for a small fee. But having stated it that way, we are essentially rediscovering narrow banks: financial institutions that take deposits and 100% back those deposits with reserves at the central bank, and provide high-speed electronic transactions services. 

Narrow banks are a wonderful idea, as they simply cannot fail, and they simply cannot suffer runs and crises.  If our regulators stipulate that all deposits must be in narrow banks, and regular banks must raise funds by selling equity or long-term debt, we would have a financial system forever immune from crises, and the regular banks would need next to no regulation. 

Why do we not have narrow banks already — either regular banks or money-market funds that offer debit cards? The paradoxical answer is simple: The same central banks and government regulators that are thinking about issuing CBDC ban narrow banks. 

They offer reasons, echoed by Lea Zicchino in a previous article in this series

First, people might run away from bank deposits in a crisis. But people, and more importantly financial institutions, already can run to cash, money market accounts, mutual funds, commercial paper, repo, and many other securities.  The heart of a run is what people are running from, not what they might run to. Substituting CBDC for bank deposits would stop, not enhance runs. 

Second if people hold more CBDC in place of bank deposits, then banks will lose a cheap source of funds, and they might raise lending rates. 

Now, any time you are asked to support regulation  that forces you to buy an overpriced (low interest rate) inefficient (slow and costly transactions) and fragile (prone to crises) product, so that an oligopolistic highly regulated industry may enjoy a lower cost of funds, that it will, supposedly, benevolently pass on to borrowers, you should be suspicious.  Perhaps that lower cost of funds goes mainly to bank shareholders and management! 

In fact banks can raise all the money they need by borrowing long-term, or by issuing equity. If our society wishes to subsidize bank lending, let us do so directly and on budget, not by forcing us all to hold inferior products. 

A second vision for CBDC, inspired by cryptocurrency, views it as a substitute for cash. The electronic infrastructure for cryptocurrency is different, and less efficient, but the financial structure of a backed central bank digital coin is the same as reserves for all. Viewed as 21st century cash, however, we do not expect the level of service that an account suggests. Forget your password, get swindled, and the money is gone, just as lost cash is gone. (Elon Musk reportedly forgot his password and lost $100,000 of Bitcoin. Too bad.) 

That vision could be provided directly by the central bank, more realistically than opening reserves to all. And many economists (not me, but an argument for another day) wish to get rid of cash, so that the central bank can implement deeply negative interest rates.

But anonymity is one of the central attributes of cash. Nobody knows how much of it you have, and nobody watches your transactions. The challenge of cryptocurrencies like bitcoin is that they offer anonymous transactions. If central banks want to displace currency, are they really =willing to allow completely anonymous transactions? 

A not-so-hidden motivation  for CBDC is to crack down on illegal transactions. But if any country, especially Italy, put a stop to all illegal transactions, its economy would come to a screeching halt. Imagine if every tax had to be paid, every informal worker fired or made legal, including every housecleaner and nanny, every transaction available for legal scrutiny? Cash is an important escape valve for idiotic regulation and stifling taxes. 

And imagine the loss of our political freedom if every transaction is written down somewhere and available for legal investigation or just embarrassing leakage. Privacy in transactions is one of the essential rights of a free society. 

But widespread tax evasion, mafia, bribery, and illegal activity is also bad for the economy and society. Cryptocurrencies are the favorite of hackers and ransomware thieves. 

Cash achieves a rough balance, just inconvenient enough to limit its bad uses, just private enough to allow some escape valve. 

We have a dilemma. Will CBDC allow full privacy? Then it will be much more efficient for all the bad illegal uses. Will CBDC transactions be visible to regulators and tax authorities? Then it will crush the economy. Can a CBDC be constructed that offers some privacy, even for formally illegal uses, but in which authorities can enforce massive tax evasion and truly illegal activity? 

That is the hard problem which our societies will have to address. It argues, I think, for digital currencies backed by central bank reserves, but operated by independent private financial institutions, who can effectively guarantee some forms of privacy and require standard protections of law before governments see the data. But achieving that balance will require the loud insistence by ordinary voters and privacy advocates on solid protections of their transaction privacy, which power-hungry governments and bureaucrats are not likely to allow on their own. 

It also argues that CBDC will force governments to reform idiotic economy-killing taxes and regulations, especially labor regulations. That’s not so bad either. 

CBDC, and its financial equivalents of narrow banks and private cryptocurrencies fully backed by central bank reserves, are no more than currency, updated to 21st century technology. Currency was a great invention. Banks used to issue currency, leading to crises. In the 19th century governments issued currency, which proved much more risk free and immune from runs. Banks were able to fund lending by other means. 

By all means let us update currency to be safer, faster, electronic, and pay interest.  We have little to fear financially, and much to gain from CBDC. Banks may lose their subsidy, and governments will have to face squarely the value of transactions privacy, and reform their taxes and regulations so that enforcement will not tank their economies. Both are added benefits, not costs. 



The literature on these issues regarding CBDC is huge. Some articles I have recently become aware of

David Andolfatto, with an interesting contrarian model showing benefits of a CBDC, " the introduction of a central bank digital currency has no detrimental effect on bank lending activity and may, in some circumstances, even serve to promote it....a properly designed central bank digital currency is not likely to threaten financial stability."

Dirk Niepelt has written a lot about CBDC theory, including reserves for all in 2015, a recent Vox-EU summary and papers,  here with Markus Brunnermeier a JME paper "CBDC coupled with central bank pass-through funding need not imply a credit crunch nor undermine financial stability," a follow up including "The model implies annual implicit subsidies to U.S. banks of up to 0.8 percent of GDP during the period 1999-2017."  Here  "reserves for all" "does not affect macroeconomic outcomes,"


  1. Wonderful essay, John. We deserve good electronic money.

  2. It seems to me that you are making compelling cases for digital and non-digital currency. I certainly support that.

  3. The word "digital" diverts from a good answer to the question at hand.

    -If anybody's digital currency floats against the lender of last resort currency, there is no problem.
    -If a Central Bank wants to issue its own digital currency, let it do so. It's then just like folding money. :-)

    P.S.: Let a thousand bills circulate. Unfortunately, I have available only bank money and $20 bills. Whatever happened to those beautiful $20 gold pieces? They don't need to have $20 worth of gold in them every day, but they must be beautiful every day. :-)

  4. I think you said a lot of correct things, but I don't think you were clear about some others.

    First: modern currencies are already digital and have been so for a a long time. Dollars are either physical notes (cash) or amounts recorded in reserve accounts at a Federal Reserve Bank (one of the 12 regional banks not the central office in Washington). All intra-bank transfers in the US are made via debits and credits to the reserve accounts. Its all digital. It was the first part of the economy to be computerized. And it happened before I left elementary school 60 years ago.

    Second, about 60% of the cash on the Federal Reserve System's balance sheet (Release H.4.1) is in mattresses in foreign countries. Cash accounts for about 30% of domestic transactions. A percentage that has been decreasing constantly for years. The pandemic has made cash less popular.

    Third, when you conduct a transaction by card, credit or debit, it is entirely digital. Paper disappeared from that system years ago. Even transactions by check are partially or fully digital now. Many merchants scan the check and send the scan to their banks. Intra-bank settlement of check transactions is now by digitally scanned image.

    Fourth, one alternative meaning of Central Bank Digital Cash that you discussed above is that it represents direct accounts of the general public with the central bank. This is not going to happen in the US. The cost of building out the infrastructure and providing the services that duplicate those already provided by card issuers and banks are enormous. A second, and this is the real killer, the banks will not let the Fed poach their customers. There are way too many banks in way too many Congressional districts and they have way too much political power for this to be a real starter.

    Further, there is an existing system that allows us residents to purchase and hold treasury securities directly from the US Treasury. It is called Treasury Direct. You don't use it and you don't know anyone who does. I and everyone I have meet invests in bonds, including Treasuries, through their brokerage accounts at places like Merrill Lynch, Edward Jones, and Schwab. Why do you think that a direct account with the Federal Reserve would be any more successful.

    Me, I am sticking with my American Express Gold Card. The service is superb.

    Fifth. Under US securities and banking laws, foreign banks, even central banks, may not issue accounts, even in dollars, to US residents unless they submit to registration and licensing by US banking and securities authorities. What those entities do with their own citizens inside their own territories is up to them.

    Sixth. I have seen repeated claims by hysterical journalists that the Chinese Central Bank will begin issuing digital Yuan. And that we are doomed if we do not follow suit. It is not legal for them to do it in the US. Further it is perfectly obvious that they want to issue their own digital currency to give themselves further power over the lives of their own people. If you think that is a good idea, I will buy you a one way first class ticket to Urumchi, Xinjiang if you promise to stay there and never come back. More to the point any American who deposits any part of his wealth with the Chinese Communist Government Central Bank is certifiably insane.

    Seventh. As you noted Bitcoin and its imitators have become the currency of extortionists hackers and drug smugglers. The Central Banks should not imitate them. They should ban them.

    Eighth. Give up on narrow banks. It is not going to happen. Plains Indian wisdom: When the horse you are riding dies. Get off. It won't take you any further.

    1. Fat Man - you summarized a lot of the same points I was going to bring up. But, since I have become an effort minimializationist, I can save the effort and say well done.

      Any time you use a digital system to log and record events of any type, there are big security issues. Look at HIPAA,for example. Digital medical records that need all kinds of security at transmission, at rest, rules who can look at that data, and remedies for breaches. Ugh.

      The bank I have allows me to Zelle money with no per transaction cost and acts like digital currency already. Your point of duplicating existing infrastructure is a good one.

      Anyway, good stuff.


  5. "Cash achievers a rough balance..." Hmm. I propose that society has achieved a rough balance, by culturally making cash much easier to use for some transactions than others. Nearly every food vendor accepts it. Used vehicle dealers, maybe. Buying a house? Leave your suitcase of small bills at home. Oh, and don't forget the precautions, some quite elaborate, that are taken against forged cash; that neat trick that Archimedes figured out is no longer enough.

  6. So-called cryptocurrencies are not anonymous. They are pseudonymous. Authorities have traced cryptocurrency transactions to criminals plenty of times. Consider this answer to an FAQ at the Bitcoin website, at

    "Is Bitcoin anonymous?

    Bitcoin is designed to allow its users to send and receive payments with an acceptable level of privacy as well as any other form of money. However, Bitcoin is not anonymous and cannot offer the same level of privacy as cash. The use of Bitcoin leaves extensive public records. Various mechanisms exist to protect users' privacy, and more are in development. However, there is still work to be done before these features are used correctly by most Bitcoin users.

    Some concerns have been raised that private transactions could be used for illegal purposes with Bitcoin. However, it is worth noting that Bitcoin will undoubtedly be subjected to similar regulations that are already in place inside existing financial systems. Bitcoin cannot be more anonymous than cash and it is not likely to prevent criminal investigations from being conducted. Additionally, Bitcoin is also designed to prevent a large range of financial crimes."

  7. Interesting that cross-subsidies seem to be the original sin that causes American financial instability as well as the problems with American healthcare! -- "If our society wishes to subsidize bank lending, let us do so directly and on budget, not by forcing us all to hold inferior products."

  8. "But if any country, especially Italy, put a stop to all illegal transactions, its economy would come to a screeching halt." That paragraph makes a crucial point. My non-rigorous observation is that Italy's periodic efforts to curb tax evasion have always failed exactly because they have never been accompanied by the reduction in taxes and regulations needed to make more above-board economic activity viable. Especially when Italy already has the 5th highest tax revenue / GDP ratio among OECD countries.

  9. "Central banks want to prop up conventional banks, who benefit from taking deposits."----JC

    There is a universe behind this sentence.

    Presently (even after QE) the Fed must implement monetary policy through a fractional-reserve banking system.

    Calling Rube Goldberg.

    Probably I disagree with JC; I think money-financed tax cuts are the way forward. Monetary policy implemented through tax cuts.

    But nice to see the topic addressed.

    Happy holidays all, and I have benefitted from another year of JC's blogs.

  10. Good article (which I promoted on my own blog and on Instagram). But I have a few minor quibbles.

    “Reserves are interest-paying accounts that banks hold at the central bank.” Reserves do not NECESSARILY pay interest: in fact I agree with the idea put by Milton Friedman and MMTers that they SHOULDN’T pay any interest.

    Re people running from traditional banks in a crisis, an additional factor that would dissuade them from doing so under narrow banking / full reserve is that under most proposed narrow bank systems, loans are funded just via equity. Thus if people do run, the value of relevant shares fall, which dissuades others from running.

    Finally, and re the objection to CBDC namely that banks would lose a cheap source of funding, a flaw in that argument (not mentioned in the article) is that “self insuring shareholders” ought in theory to charge the same as a deposit insurance system for carrying relevant risks.

  11. I am not sure that I understand the business model of the narrow bank. Would they just provide checking and savings accounts to the public while collecting interest from the Fed?
    If it was mandatory that all assets of depositary institutions be held at the Fed, why would the Fed pay interest on these accounts?

    Mike Bowler

  12. What if banks issued their own currency? Exchange rates between and among them would account for currency risk, much like FX exchange rates. If the market was complete, market risk would be neutral. Covered interest interest rate parity would, theoretically, eliminate arbitrage between banks with different interest rates.


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