The Reserve Bank has a consultation document out inviting public feedback on the idea – to which they express themselves sympathetic – of the Bank possibly, at some stage in the future, issuing a new central bank digital currency, to which members of the general public would have access (unlike their existing wholesale digital currency – exchange settlement accounts – that only (some) banks currently have).

I wrote a post last week on Barry Eichengreen’s recent seminar for the University of Auckland and some of my own ideas, notably the idea that there is little reason to suppose there would be much demand for such a product (unless subsidised or underpinned by other distorting regulation).

Submissions close on Monday – at the curious hour of 10am. I spent a few hours this afternoon jotting down some thoughts as a submission. No doubt various bankers will make longer, more detailed, and more bureaucratically expressed, submissions on various points (and perhaps some academics might make some more mathematical ones), but I suspect my submission will still offer a reasonably distinctive angle.

The full submission is here

Central Bank Digital Currency submission 4 December 2021

My summary ran as follows:

The case for a possible future central bank digital currency is not persuasively made, and seems to rest on very weak (some simply inaccurate) analytical foundations and characterisations of history, inflated with overblown claims about the role of central bank money. There may be a case, at some point in the future, for a very basic form of digital central bank-issued New Zealand dollar to be available for use by members of the general public. But I would expect that demand for any such product (so long as fairly-priced and not supported by regulatory restrictions on other forms of money) would be quite limited, both in normal times and perhaps even in (extremely rare, by construction of prudential policy) systemic financial crises. This is consistent with the experience with physical central bank money, which is used largely only because private issuance is outlawed. In the shorter-term, and whether or not the Bank ever issues a general purpose CBDC, a much more liberal approach should be taken to allowing
access to the Reserve Bank’s exchange settlement account system.

And here are a few paragraphs

The weaknesses in the consultation document start early. For example, there is the grossly overblown claim on page 6 that “central bank money can be considered systemic in all societal domains [whatever that means] – it underpins people’s …. environmental, social and cultural wellbeing”. There is no analysis presented in support of a claim that seems almost laughably inconsistent with the fact that most countries didn’t have central banks until 100 or so years ago. Central bank money has a useful, indeed important, potential role to play in macroeconomic stabilisation – the reason the Reserve Bank of New Zealand was established – but the implied suggestion that without their new central banks our grandparents (or the greatgrandparents of Americans) somehow had impaired cultural or environmental wellbeing [again, whatever either phrase means] seems, at best, a stretch.

and

Weaknesses pervade the consultation paper. For example, the Bank claims the issuance of a CBDC would “support the ability of central bank money to act as a fair and equal way to pay and save in our modern and inclusive economy”, and has a lot of handwaving rhetoric around “financial inclusion” without (a) any serious attempt to document the nature and scale of any such issue or (b) any serious analysis of alternative options, if there is an issue.   As far I could see, for example, there was no data in the paper outlining the percentage of the New Zealand resident (and legal) adult population that (a) does not have a bank account, and (b) would like one.  Since even welfare benefits are (almost?) exclusively paid by direct credit to a bank account, it seems hard to believe that – for now anyway – there is a problem in New Zealand.   We are not the United States.  And when the Bank attempts to suggest that a CBDC might help those who are not just unbanked but those who are “underserved by the private sector by offering basic services at low or subsidised prices”, there is no attempt to rigorously analyse who might be “underserved” (or even how that might be defined) let alone why Crown subsidies, via the Reserve Bank, might be desirable.  Similarly weak, in the same section of the paper, is the claim that provision of a general purpose CBDC would be a “public good”.   Being issued by a public agency does not make something a “public good”.

and

The consultation paper expresses some unease about the possibility that a retail CBDC could either (a) disintermediate banks (or other private deposit-takers), and/or (b) destabilise the banking system in periods of stress by making it (a little) easier for retail depositors to run. The former is unlikely, and if it were to happen would have to revealing something about either (a) public confidence in the soundness of the financial system or (b) the pricing of the product. As the Bank will be well aware, one can generate a demand for almost any instrument if the price is right (or rather, wrong). Retail government inflation-indexed bonds were very popular in New Zealand for several years in the late 1970s and early 1980s, but only because they paid such a high yield (especially after-tax) relative to anything else the market could offer. Pricing of any CBDC instrument could relatively readily be set to keep demand to quite modest levels, if in fact there was revealed to be much demand at all.

and

There is some discussion of issues around so-called “monetary sovereignty” in the Bank’s papers. Whatever this actually means, there is no serious discussion as to how private payments developments might threaten the ability to conduct an effective monetary policy in New Zealand, or how a CBDC might materially limit any such risk. There was talk of the risk of “global stablecoin” somehow displacing New Zealand dollars, but there was no analysis – grounded in how use of individual national currencies has changed over time – of why such an offering would materially affect anything about the ability of the Reserve Bank to conduct an effective monetary policy. As the Bank will know, much about the usefulness and effectiveness of national monetary policy rests in the stickiness of domestic non-tradables prices and wages. As long as, for example, labour is contracted for in New Zealand dollars, and New Zealand wages are sticky, monetary policy will, in principle, be able to undertake countercyclical stabilisation policy. And if ever that contracting in the real economy changes – as to currency or flexibility – New Zealand monetary policy will no longer be effective (or perhaps necessary). But short of hyperinflations I think the Bank would struggle to identify examples where domestic monetary policy has become so attenuated, or to explain how an offshore stablecoin, backed by some
other national currency, could be likely to displace the NZD for the vast bulk of transactions,
occurring onshore in the same currency as almost all of us earn.

For those who want some more reading on this, I can recommend a thoughtful speech given a few months ago by Federal Reserve Governor Waller, headed CBDC: A Solution in Search of the Problem. Hard to disagree with that sentiment.

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

On Monday 10 July 1967 New Zealand adopted decimal currency. Presumably the government chose a Monday because in those days shops in only a few areas were open on Saturdays and almost all shops and other businesses were closed on Sundays.  Nothing else very significant seems to have happened in the world that day, and no one very famous was born on it.    We adopted decimal currency a year after Australia did and four years before the United Kingdom did.

But of course the dollar isn’t what it used to be.   Here is a chart of the purchasing power of $100, based in June quarter of 1967.   By 1975, purchasing power had halved (prices doubled), by 1980 it had halved again, and even since the current Reserve Bank Act was passed in December 1989, mandating the Reserve Bank to achieve and maintain a stable general level of prices, consumer prices have increased by 76 per cent.   $100 today purchases what $5.60 purchased in 1967.

So much for price stability.   As I was typing this I noticed that the Reserve Bank had put out a press release to mark the 50th anniversary.  The Governor notes

“This milestone is a great opportunity to reflect on a point in time and see how our banking has evolved and how our money has changed over the years.

Perhaps also an opportunity to reflect on the declining value of that money?

Of course, shifting to decimal currency itself didn’t materially alter the average inflation rate.  What did that was the establishment of the Reserve Bank itself in 1934 (at which point private issuance of banknotes was also outlawed).

Prior to the creation of the Reserve Bank, the price level tended to be quite stable over long periods of time (but rather less so in the short-term).

There are good reasons for having a Reserve Bank (although the case is less overridingly compelling than the advocates sometimes claim), but it is worth being aware of what was lost when central banks and fiat money replaced earlier systems.   We lost, for example, any sense that money today will be worth roughly what it was in your grandparents’ time and what it will be in your grandchildrens’ time.  Does it matter?   On the one hand, we don’t mess around with, say, weights and measures that way.  A metre is what it was generations ago, and what it will be generations hence.   Weights and measures are social conventions too.    A reasonable counter is that very few people, other than governments, enter into long-term nominal contracts, but that might be partly because the future price level is so uncertain, while the future length of a metre isn’t.   In practice, there seem to be wider economic advantages in some circumstances is being able to generate unexpected changes in the price level (and alter the exchange rate), but whether they are worth the costs –  including the mismanagement by governments and central banks at other times –  is worth reflecting on from time to time.

When governments monopolised note issue (through the Reserve Bank) we also lost the opportunities for competitive innovation in hand-to-hand payments media, and left ourselves reliant on monopoly government suppliers.  Those sorts of suppliers usually don’t do a particularly good job in providing high quality goods and services in other areas of commerce, and it isn’t clear why we should expect much different in banking.  The state doesn’t monopolise the issuance of electronic payments media, and look at the innovation we’ve seen there.

Regrettable (and unnecessary, even if you wanted a central bank) as the statutory prohibition of private banknotes is, one might have supposed it was becoming increasingly less relevant.   If it is true in some countries, it isn’t here.  Here is a chart of the value of bank notes held by the public as a per cent of GDP.

If bank notes are now being used for a smaller proportion of (licit) transactions, perhaps they are still being heavily used as a store of value (as the opportunity cost of holding cash has fallen, as interest rates have fallen) and for illicit transactions?

I was interested to see the outgoing Governor comment today on future prospects for physical cash.

Despite the growth in electronic payment systems, cash in circulation continues to grow and I expect cash, as a means of exchange, to be around for a long time yet.

The problem is that not only is cash becoming more popular, but we are getting nearer the point where it could either (a) become a great deal more popular indeed (if the Reserve Bank wanted to cut interest rates very much below zero),, or (b) where that option could severely limit the ability of the Reserve Bank to use monetary policy effectively in a severe downturn.  That ability is the main reason for having a Reserve Bank, and discretionary monetary policy, in the first place.

I noticed that the Governor did qualify his observation about the future of cash, noting that he expected it to be around “as a means of exchange” for a long time yet.   Did he mean to suggest it might not be around for long as a store of value?     It is the sort of the issue the Reserve Bank needs to address more extensively and openly.

The 50th anniversary of decimal currency is a good opportunity for some fun, looking back at what the country was like at the time of the changeover.    But after a few hours of looking back, it is probably rather more important for our officials –  in the Treasury and the Reserve Bank –  to be thinking hard about the constraints their statutory monopoly is coming closer to placing on our ability to use monetary policy for what is is designed for.    I’ve long favoured removing the statutory prohibition on private banks issuing bank notes.   Perhaps doing so wouldn’t come to much, but we can’t know if we keep the prohibition in place.  Perhaps they’d develop technologies combining the convenience of hand to hand currency with the potential for a variable rate of return?

But perhaps more immediately pressing now is a clear programme of work to ensure that when the next serious downturn comes we can have both the advantages of our existing physical cash as a payments medium (and even as an anonymous store of value) and the flexibility that discretionary monetary policy is supposed to have given us.  At present, we are drifting towards the rocks –  the next serious recession, whenever it happens –  with no sign that the Reserve Bank (and other relevant agencies/ministers) are taking the risks at all seriously.    It is another issue for the Reserve Bank Board to have in mind in assessing the applicants for Governor.  After all, one dimension of leadership is looking a little further ahead than other people, and charting directions.