Summary
Paper money is a risk-free asset for an individual or business that holds it and a liability of the central bank that issues it. Paper money works well as a medium of exchange for small value payments that are made "in person," but it does not work as well for payments that are large in value or need to be made remotely.
Many central banks are contemplating the issuance of their own digital currencies. Similar to paper money, these so-called central bank digital currencies (CBDCs)would be a liability of the central bank and a risk-free asset of the public. Large value payments and remote payments could be made easily with CBDCs, and payments would clear essentially instantaneously.
But there are complex design issues associated with CBDCs. Bank deposits, which are the liabilities of private sector commercial banks, constitute the vast majority of the money supply of most economies. A CBDC could compete with bank deposits, which could lead to disintermediation from the banking system, especially in times of financial stress. Disintermediation could have devastating consequences for economic growth.
The People's Bank of China (PBoC) recently issued the Digital Currency ElectronicPayment (DCEP) on a limited basis, making it the first major central bank to launch a digital currency. The DCEP is a liability of the PBoC, but the public acquires it from commercial banks, not directly from the central bank. The DCEP does not pay interest, which should limit the potential disintermediation effects of the digital currency in the Chinese banking system.
Advanced economies are lagging behind in terms of CBDC issuance. Work on a CBDCin Sweden, which increasingly has become a "cashless" economy, has been underway for more than four years. The Swedish central bank completed a test of an e-krona last year, but no decision has been reached yet about whether to actually issue a CBDCin Sweden. The European Central Bank expects to have a prototype of a digital euro ready for testing sometime in 2023.
The Federal Reserve recently published a report that lists some basic principles regarding the potential issuance of a U.S. CBDC. But the Fed essentially kicked the decision about the creation of a digital currency back to the executive branch and congress.
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