Why have people used Reserve Bank of New Zealand physical notes?

The simplest, and almost entirely complete, answer is that almost 90 years ago Parliament banned any other notes, creating a statutory monopoly for the newly-created central bank. It wasn’t a necessary part of setting up a central bank – although it was a common restriction elsewhere too – but simply a political choice, not to out-compete the note offerings of the trading banks, but simply to outlaw them.

The Reserve Bank is currently consulting on a couple of documents, including one specifically on the possibility of them, at some stage in the future, beginning to issue an additional digital Reserve Bank liability (a “central bank digital currency”) that, in one form or another would be accessible to individual members of the public. Somewhat strangely, in all those many pages there is no discussion at all of how demand for their existing liabilities arose or was sustained.

I’ll come back to the Reserve Bank documents later in the post, but first I wanted to talk about a nice lecture on central bank digital currencies given, at a University of Auckland hosted event a couple of weeks ago by Professor Barry Eichengreen, a prominent US economist based at Berkeley. It was part of a post-APEC conference, so I’m assuming taxpayer cash went to getting Eichengreen – who can’t have come cheap and (surprisingly) didn’t seem (judging by Zoom numbers) to attract a vast audience. Anyway, the recording of his talk is here. (For anyone who wants some more reading, you might also consider Cornell professor Eswar Prasad’s new book, The Future of Money: How the Digital Revolution is Transforming Currencies and Finance.)

[UPDATE: One of the organisers kindly got in touch to tell me that not only was there no public money involved, but that Eichengreen provided his time free, in the interests of encouraging debate on these issues in New Zealand.]

It would be fair to say that Eichengreen is not a fan of central bank digital currencies (CBDC). He structured his task around five arguments sometimes made in favour.

The first is the claim that a CBDC might “be useful for improving the efficiency of payments”

But as Eichengreen noted, there are already lots of digital payments options (he cited Paypal, Visa, Apple Pay, and Venmo – the latter apparently good for peer-to-peer payments, at least if you don’t mind your payments being visible to everyone). Central banks apparently like to claim that they could offer a cheaper service (he cited various numbers for the cost of each the products he mentioned), but he argued that even if central banks charged lower headline prices (a) this would only be a social gain if, over time, they were really more efficient than private providers, and (b) it wasn’t at all obvious that payments technologies of this sort were, or should be, a natural monopoly. Not all payments media are accepted by everyone, or are used for all purposes, and in his view a “diverse eco-system” was likely to be more robust, noting (for example) the recent Facebook outage. It seemed unlikely, he argued, that over time central banks would be at the leading edge of innovation. Even if a CBDC co-existed with private payments media etc – which seemed the most likely scenario – then the savings to consumers would still be much less than was suggested by the headline numbers (he made quite a bit of the fact that a Visa card might involve an annual fee, but also provides a credit line, and the ability to block payments for defective etc merchandise, so a bundled product that can’t just be compared to a basic payments service).

The second argument sometimes advanced was that CBDCs should be issued to help keep control of the payments system, including visibility of payments flows/data etc. He didn’t find this story remotely convincing (and neither do I), pointing out that there are plenty of regulatory oversight and data-gathering powers that either exist already or could be put in place. He wasn’t unsympathetic, for example, to seeing stablecoin products regulated like banks.

Financial inclusion was the third argument Eichengreen addressed (it is one our Reserve Bank seems keen on). As Eichengreen noted, in the UK apparently 2 per cent of the population doesn’t have a bank account, a number rising to 7 per cent in the US. In principle, everyone could have access to a downloadable central bank “wallet”. Such a product might, it is argued, make it easier for things like Covid lump-sum grants to be distributed. He argued, however, that this was a solution in search of a problem, and that other methods are available – including (I suppose) that one might require banks to offer simple deposit/transfer products to all comers. (In a New Zealand context it seems even less likely to be an issue, since one can only get a welfare benefit with a bank account, suggesting that access to a basic bank product is not a major obstacle.

The fourth argument Eichengreen addressed was the idea that a CBDC – or a linked network of them – might enhance the cross-border payments system, which is still typically very expensive at the retail level.

But as he noted, other providers are already experimenting including (he said) SWIFT, and Visa & Mastercard are experimenting with stablecoins. Moreover – and I think was his more important point – it was hard to envisage a global governance (and security) model across 120 or more central banks and their CBDCs. His assertion was that “it won’t happen in our lifetimes” (he is 69).

The final argument that Eichengreen addressed in his talk was that CBDCs – presumably some international linked model – could be a vehicle for reforming the international monetary system (itself typically a shorthand for “reducing the dominance of the US dollar – itself with at least two dimensions (the denomination of foreign reserves, and the use by the US of the dominant position of the dollar to impose and maintain sanctions). The model being addressed here seemed to be some very ambitious international model – and thus not very relevant to the New Zealand discussion – in which the IMF might issues something akin to the SDR, backed by a basket of national CBDCs with similar weights to those for the SDR). Some have argued that such an instrument might be attractive for holding foreign reserves.

He noted that the US Congress would be unlikely to agree to such issuance, but even if it did it simply wasn’t obvious there was the demand. The SDR itself never lived up to expectations and serves now as little more than a disguised system of foreign aid from time to time. There are few SDR-denominated products and the SDR is no one’s natural habitat. As he noted, the initial Facebook proposal for LIbra had been based on the idea of a basket of currencies, but that had now been scrapped and the current proposal is for a dollar-linked stablecoin.

At the end of his talk, Eichengreen’s summary observation was that “the case for CBDCs remains to be made”.

An interesting q&a session followed. Former Reserve Bank Deputy Governor Grant Spencer asked Eichengreen if he saw any arguments for a CBDC. Eichengreen’s response was that there were no strong arguments in favour, that the financial inclusion arguments were “all specious”, and that a range of private payments options already provided a superior mix of services. Spencer followed up asking about a scenario in which private and CBDC solutions co-existed. Eichengreen’s response was that one would need a proper cost-benefit analysis, but that he still wasn’t convinced of the case, noting risks such as botched software updates, hacking of central bank systems, and concerns about disintermediating commercial banks and increasing the risk of bank runs.

Another questioner asked about Eichengreen’s preference for regulation over direct central bank provision, noting “repeated failures of bank regulation”. In response, Eichengreen noted the concentration risks if a CBDC became a dominant product [as central bank notes did], but did note that there was no ideal solution and inevitably regulators would struggle to keep up.

A questioner asked about the US sanctions issue. Eichengreen repeated his scepticism that CBDC could make much difference any time soon, and noted that there were other innovations that were perhaps more likely to reduce the salience of this issue (apparently China is currently developing an alternative to SWIFT.

There followed a private roundtable session. I won’t write much about it because the Chatham House rules were so tight that I can’t even tell you who was speaking. But one speaker did take the opportunity to push back on the notion that CBDCs would increase the risk of bank runs, and should not be adopted for that reason. This speaker made a point (I have long shared) particularly vividly that the way to deal with the risk of a panicked rush out of a crowded theatre was not to bolt the doors, adding that avenues for runs had in any case increased enormously in recent decades and (for example) much about the 2008/09 crisis was wholesale runs. Perhaps the most I can say is that people closest to government agencies seemed most upbeat about what value a government product might add.

What of my own position? It is probably a bit more open to the possibility of a CBDC than you might expect, even as I don’t regard it as a high priority, and am a bit surprised at the resources the Reserve Bank is putting into the issue, even as it has done nothing about dealing with the effective lower bound o nominal interest rates that arises (at present) solely because of (a) the Reserve Bank’s monopoly on the note issue, and (b) its standing offer to convert settlement cash to physical currency at par. That still looks likely to be a big problem in the next serious economic downturn brought on by a persistent or sustained slump in demand.

But, for what it is worth (and I will try to flesh some of this out in a submission in the next few days, which I will post here in due course), my approach is that if banks have access a central bank (risk-free) digital form of the New Zealand dollar (as they do, through exchange settlement accounts), the public should have access to something similar. When I was a central banker, I used to strongly favour open access to exchange settlement account services, and although that wasn’t quite the same thing, it was consistent with this philosophy that we should not be privileging banks (or financial services providers or large players). It is also the only reason I favour the Reserve Bank being open to offering a CBDC. They will never have a technological advantage. Financial inclusion arguments don’t wash (in New Zealand). So-called monetary sovereignty arguments also don’t wash – the issues there are much more about what currency people contract labour in than what products payments are made with. But there is a reasonable case for a barebones safe digital store of value.

But – and here we come back my introductory remarks about why we have used Reserve Bank notes for decades – I don’t believe there would be much demand for such a product. Why would there be? Most people are clearly content to take a modest amount of credit risk and deal in bank liabilities. Most of us give little thought to the modest risk in holding bank account deposits and using those accounts to make most of our payments. Moreover, banks often market bundled products that no central bank would or should be competing with. For particularly risk-averse savers the government has long offered Kiwi Bonds, but very few people buy them. So whether as store of value or means of payment I see no reasons to suppose that a New Zealand CBDC – issued in a country with one of the best-capitalised banking systems on earth – would find many takers. Perhaps I might get myself an account as a curiosity, but I couldn’t imagine using it at all (actually in days one by the Reserve Bank used to offer cheque accounts to its staff, and I kept that account mainly as a curiousity and talking point).

What of the risk of runs? Well, as already noted there are lots of ways to run, and it isn’t obvious we should make it harder for ordinary people than for large investors. More to the point, runs are often quite rational, and the potential to run can be a valuable market discipline. In fact, signs that people were beginning to move into a CBDC might offer some (small) further useful information for bank supervisors. We can’t worry endlessly about moral hazard and assumptions around too-big-to-fail, and still lament products that might enable people to better respond to changing perceptions of individual bank risk.

There is no real analysis of the likely demand for a CBDC in the Reserve Bank material (and not much discussion elsewhere that I’ve seen), assuming governments didn’t try to corner the market for a new central bank product. But if I’m right about the limited demand, it would enable us to set aside one of the real concerns some have raised about a marked increase in the size of central bank balance sheets: we do not want central banks in the business of allocating credit in the economy, by their choices about what assets to invest proceeds of their currency issuance in. If there were no additional demand, it wouldn’t be an issue.

Were I a central banker, however, one concern I might still have – and again the Bank doesn’t appear to treat it – Is the potential for the central bank to be caught up in questions of who should be allowed an account.  Cash is anonymous.  Central bank bank accounts are not. When “the mob” looks askance on some person or group, it isn’t hard to envisage demands coming from some quarters for this that or the other group to be denied access to a CBDC. Even if the Bank successfully resisted – in an open society surely accounts would have to be open to all – it is the sort of controversy they might well prefer to avoid.

That is probably enough for now. I hadn’t thought much about these issues for a few years, but was pleasantly surprised to find that the views expressed in this 2017 post seem fairly consistent with those in this post today.

UPDATE: My submission

Central Bank Digital Currency submission 4 December 2021