Like all other major central banks, the Federal Reserve is concerned about the economic consequences of the pandemic. For now, dealing with unprecedented supply shocks is his first order of business. But another problem also deserves special attention, albeit more discreetly. In due course, it will go behind the scenes, take on enormous importance and involve all aspects of central bank policy: what exactly is the future of money?
Reflecting on this question, the Fed and its counterparts are not leading a revolution so much as they are struggling to catch up with one. Technology has transformed the monetary system in recent years, and at an accelerating rate. Paper money is falling into disuse as consumers turn to more convenient electronic payments, using bank accounts, credit cards and other online systems.
As a result, apart from Bitcoin and other cryptocurrencies, advanced economies are cashless. Paper money was used in about 40% of transactions with U.S. consumers in 2012. By 2019, the proportion had fallen to about a quarter. In 2020, as the pandemic boosted e-commerce and led some mainstream retailers to refuse cash, the share fell to 19%.
This transition will surely have many benefits, but there is an undeniable risk: even if cash is no longer the primary means of settling transactions, it is a valuable safeguard. Regulators can do all they can to ensure the robustness of private payment systems, but things can still go wrong – and, if they do, the ability to pay in cash offers crucial additional resilience.
One potential answer to this dilemma is known as central bank digital currency. Retail CBDCs are electronic money, held by businesses and individuals in accounts at the central bank, operating on a separate strong and sustained network, like paper money, by the full faith and credit of the government. They would still be vulnerable to (say) a shutdown of energy and data systems – but other than that, they could go far to fill the space freed up by physical money.
In fact, they could be a big improvement. In their role of monetary safeguard, CBDCs could be used in a much wider range of transactions, including electronic commerce. They could stimulate new payment systems and put competitive pressure on incumbents, thus increasing efficiency and lowering costs. They could also meet the demand for innovations like stablecoins – cryptocurrencies supposedly backed by other assets – without threatening financial stability.
Finally, CBDCs could serve a purpose that ordinary cash cannot, by creating a new channel for monetary policy. Instead of indirectly influencing interest rates, by operating on reserves held by banks and other financial institutions, central banks could adjust the interest they pay on retail CBDC balances.
Of course, all of these opportunities come with possible drawbacks. The advantages of the CBDC as a payments system might initially be so great that they would bankrupt existing systems, for example, in which case there would be less competition and innovation. In addition, the greater the perceived benefits of the new electronic money, the less likely businesses and individuals will be to hold paper money and deposits in commercial banks. Such “disintermediation” would have big implications for the way banks finance themselves and could potentially reduce commercial bank loans or make them more expensive.
Alternatively, if central banks chose to support the supply of credit by expanding their own balance sheets and channeling alternative funding to commercial banks, they would be drawn deeper and deeper into choices they would rather not make – and their claims to independence, already under pressure, would appear increasingly uncertain.
None of this will be easy. When fully engaged, this debate will likely simplify the political questions raised by the pandemic. But there will be no way to avoid the discussion. One way or another, the cashless society is coming. Central banks will have to decide: are they just letting this happen or are they seizing the opportunity to shape the future of finance?