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 Designing New Money

Executive Summary

The prospect of central banks issuing digital currency not only raises the question of whether this is a good idea or not. There are several variables in the design of a central bank digital currency (CBDC) thus raising the question of how to design such a new form of money. This is the question explored in this paper. The paper poses the question of the design of CBDC not merely as a technical

but also as a political question. Before we can determine, what is the optimal design of CBDC, we have to decide, what we want this kind of money to do for us. What is the purpose of implementing CBDC? This is a political question in so far as different CBDC design models serve the interest of different groups of agents in the economy. The purpose of the paper is to point out the political nature of the question of CBDC as well as to map out different scenarios for the design and implementation of this kind of money.

Old Money and New Money 

The paper defines CBDC as the three kinds of money constituting the existing monetary system: cash, bank money, and central bank reserves. The characteristics of these three kinds of money relative to CBDC are analyzed through the Venn diagram below.

The idea is that each of the existing forms of money is defined through the lack of one of the three features: electronic, universal, and central bank issued. The illustration also shows how CBDC integrates all of these three features. CBDC thus potentially competes with each of the three existing forms of money. This allows us to pose the question of the design of CBDC in terms of the way that CBDC should supplement or replace any of the existing forms of money. Assuming that CBDC replaces existing central bank reserve money, the issue of the design of CBDC may be broken down into two key questions: 

- Should cash be abolished with the implementation of CBDC or should the two forms of money co-exist?

- Should bank money be abolished with the implementation of CBDC or should the two forms of money co-exist?

Depending on the way that these two questions are answered, there are four
different ways of combining CBDC with existing money each constituting a particular design model of the monetary system: 

1) CBDC is complementary to both cash and bank money 

2) CBDC as a replacement for cash and complimentary to bank money 

3) CBDC as a replacement for both cash and bank money 

4) CBCD as complimentary to cash and a replacement for bank money. 

The monetary policy implications of models 3 and 4 are not considered to differ significantly and they are thus treated as one model.

The Policy Trilemma of CBDC 

To evaluate the policy implications of each of these three design models, the paper develops an adapted version of Mundell, Fleming, and Obstfeld's classic monetary policy trilemma. The conventional trilemma illustrates the relations between a domestic and a foreign money creator in the form of two different central banks. Our trilemma illustrates the relations between two domestic money creators in the form of the central bank and the commercial banking sector. The domestic monetary policy trilemma is posed in the following fashion:

- The conventional policy objective of exchange rate management between
two currencies translate into the domestic policy objective of securing financial stability by maintaining parity between commercial bank money on the one hand and CBDC and cash on the other. 

- The conventional policy objective of monetary autonomy in decisions on
central bank interest rates translate into monetary sovereignty, which is the prerogative of the monetary authorities to use CBDC not only as a monetary policy tool to support commercial bank credit creation but also as a fiscal policy tool to stimulate the general economy. The abandonment of monetary sovereignty means that commercial banks are the primary drivers of money creation. 

- The conventional policy objective of free capital mobility translates into free convertibility between commercial bank money and central bank money. We may understand the implementation of CBDC as the introduction of such convertibility. With universal access to the central bank balance sheet, ordinary money users now for the first time have the option to choose between holding electronic money with the central bank or with commercial banks. The gist of the trilemma is that monetary authorities can only pursue two out of the three policy objectives. 

Three Scenarios 

The main analytical section of the paper applies the domestic monetary policy trilemma to each of the three possible CBDC design models. The current situation, where convertibility between commercial bank money and central bank money is highly inconvenient for money users as they would have to hold physical cash, means that the monetary authorities are now in the (C) position. The introduction of CBDC opens up the possibility of free convertibility between commercial bank money and central bank money. This means that the central bank must either give up using monetary policy and interest rate adjustments for any other purpose than defending parity (A). Such an approach would immediately correspond to the design model (1). But pressure on parity could ultimately force the central bank to phase out cash to allow for CBDC interest rates to go negative thus leading to a design model (2). Another option is for the central bank to give up taking responsibility for parity between CBDC and bank money (B). This would amount to design model (3) or (4) as bank credit money would no longer have the status of money but be merely a particular form of commercial credit.