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 The Policy Trilemma of Central Bank Digital Currency

From Monetary Policy to Monetary Politics

One of the great questions of counterfactual history is this: What would the world look like today, if John Maynard Keynes' proposal for a Bancor had been adopted at the 1944 Bretton Woods Conference? The Bretton Woods system came to define the exceptional role of the United States in the global economy by establishing the US-Dollar as the anchor of the international monetary order thus making it the new world reserve currency. In contrast to this model, Keynes had envisaged a truly supranational currency in the form of the Bancor, which would be beyond the control of any single state and thus put all of the national currencies on an equal footing. Thinking through the hypothetical scenario of the adoption of the Bancor proposal brings to mind the real economic and political significance of an initial technical difference in the design of a monetary system. The technical design of the Bretton Woods was constitutive of the post-war economic world order.

The topic of the current paper is the proposal for implementing central bank-issued digital currency (CBDC). 

Hiding behind the inconspicuous acronym  CBDC is nothing short of an entirely new form of money. While the true potential of such an arrangement may not be immediately evident to the non-expert eye, it could nevertheless constitute a radical innovation in the constitution of our money system in the same category as the introduction of paper money. As in the case of the Bancor and the Bretton Woods, it is crucial to understand how technical differences in the design of CBDC have profound economic and political implications when this new money is implemented. The purpose of the paper is to bridge the technical dimensions with the economic and political dimensions of the question of CBDC.

In the immediate aftermath of the financial crisis of 2007-8, there was a window of opportunity for financial reform. Banks and private financial institutions were on their knees. They needed liquidity to prevent money markets from freezing, assets prices from deflating, and themselves from going into insolvency. Governments and regulatory bodies could have used this opportunity to impose reforms on the banking sector not only to create a more stable system but also to take back some of the control over the economy and society, which had been concentrated in the financial sector over the past four decades of increasing financialization.

Instead of exploiting this opportunity for change, the general trend in the responses from governments of the economies struck by the crisis was to aim for a restoration of the status quo. The priority was to bail out the banks by using the central banks as providers of ample amounts of cheap money as well as sinks to offload toxic assets. These state subsidies to the banks were presented as inevitable technocratic measures and their true content was obscured under acronyms such as TARP and QE. Not only did they serve to reboot the balance sheets of private financial corporations and allow them to swiftly return to pre-crisis levels of profit-making, but they also shifted the balance of economic and political power back to the advantage of the financial sector. The burden of the crisis was transferred onto the public budgets and the central bank balance sheets with ordinary citizens and taxpayers left to pay the bill in the form of austerity, public utility privatizations, political impotence, and continued anxiety about when the next crisis is going to strike.

The idea of central banks issuing universally accessible digital money has been circulating among academics and activists for more than a decade. The true novelty is that within the past 1-2 years, central banks have begun to publicly announce interest in the idea. Here is how the Bank of England speaks about the matter:

If a central bank were to issue a digital currency everyone, including businesses, households, and financial institutions other than banks, could store value and make payments in electronic central bank money in addition to being able to pay with cash. While this may seem like a small change, it could have wide-ranging implications for monetary policy and financial stability.

This opens a new window of opportunity for monetary policy measures that do not just serve to patch up the existing system but engage with its core fundamentals. If we think of monetary policy as incremental adjustments to continuously calibrate an existing system, the question of CBDC should be conceived as a matter of monetary politics. The policy is a plan to achieve certain predefined ends. Politics is the discussion, decision, and thus definition of these ends.

There are plenty of reasons to be excited about the growing interest in CBDC from people and institutions, who have the power to make it happen. At the same time, it is also important to insist that the question of whether and how to implement this new form of money should not only be a decision made by central bankers. The responsibility of central bankers is to implement monetary policy. It is not to make political decisions on money. The hallmark of democratic societies is the involvement or at least the representation of those citizens affected by a political decision in the making of this decision. This is especially the case with constitutional matters such as the making of laws, the collection of taxes, or the use of legitimate force. Decisions on who should create which kinds of money in our society belong in that same category. The aim of this paper is thus to broaden the scope of the debate on CBDC to include people outside of the narrow circles of central bankers and other monetary policy insiders.

Current Debate and Research

In February 2015, the Bank of England posed the following question in its 'One Bank Research Agenda':

From a monetary and financial stability point of view, what are the costs and benefits of making a new form of central bank money accessible to a wide range of holders?

Since the initial formulation of the question of CBDC, the Bank of England has launched a research program on the topic as well as made several public announcements discussing the prospects of implementing its digital currency. Comparable efforts are found in other central banks around the world. The Peoples Bank of China recently stated in Bloomberg:


In recent years, digital currencies have shown considerable promise. Research by the People's Bank of China suggests that the best way to take advantage of these innovations is for central banks to take the lead, both in supervising private digital currencies and in developing digital legal tender of their own. At the PBOC, this effort is underway. ... Since 2014, under the guidance of Governor Zhou Xiaochuan, the PBOC has attached high importance to the development of legal digital currency.

In a similar vein, the Swedish Riksbank stated in November 2016:


The Riksbank is one of the central banks that will need to take an active stance on whether or not to issue a digital currency first. We cannot wait any longer, and I shall now tell you what we intend to do in the coming years.


Other central banks reported to have initiated research into Central Bank Digital Cash include at the time of writing least the central banks of Canada, Russia, Senegal, Norway, Australia, Japan, Singapore and Hong Kong. David Andolfatto has floated the idea of a FedCoin, which would be a US version of CBDC, although he was not speaking on the issue in his capacity of Vice President of the Federal Reserve Bank of St Louis but as a private individual. The issue has subsequently been picked up by Federal Reserve Governor, who discussed it briefly in a speech . Recently, the issue has also been raised in a speech by a representative of the European Central Bank:

The ECB would in particular have to understand the impact – positive or negative – of DBM [Digital Base Money - OB] on our primary objective of price stability before considering introducing it. Moreover, any value judgment on DBM needs to be assessed against several high-level principles, namely (1) technological safety, (2) efficiency, (3) technological neutrality, and (4) freedom of choice for users of means of payment (Mersch 2017) And the European Parliament has commissioned a report quite boldly stating that:

A digital currency could also be issued by the central bank and potentially substitute for bank deposits as the main form of money holding of households and businesses. This would challenge the present fractional reserve system at its core. Increased instability of monetary aggregates and credit supply would be a possible outcome if market participants shifted liquidity pro-cyclically between digital money and bank deposits. Commercial banks would increasingly have to rely on other funding sources than deposits so that this disruptive change to the fractional reserve system could finally pave the way for a more stable financial system.

In response to these announcements, researchers have already started to evaluate the possible implications of CBDC. Probably the first and certainly the most comprehensive study of the issue so far is the paper 'The Macroeconomics of Central bank-issued digital Currencies' (2016) by Barrdear and Kumhof from the Bank of England. This is a DSGE modeling of the effects on growth, inflation,


interest rates as well as several other macroeconomic variables from the implementation of CBDC. A series of other papers take a more theoretical approach by developing conceptual frameworks for discussing the risks and opportunities in implementing CBDC. These papers come from different institutions such as the Bank of Canada, the Swedish Riksbank (Camera 2017 by commission), the First Rand Bank in South Africa (foundry 2016), the Inter-American Development Bank (Ketterer et al. 2016), Banco Bilbao Vizcaya Argentaria (Gouveia et al. 2017), as well as the NGO Positive Money (Dyson and Hodgson 2016).

Structure of the paper

The paper begins with a description of the current monetary system, which consists of three kinds of money: cash, bank money, and central bank reserves. The description of existing money forms a baseline for the subsequent definition of CBDC and evaluation of its possible implications. The description is then complemented with a distinction between three different perspectives on the nature and functioning of money. Depending on the way we think about money, we will have different kinds of concerns about the implementation of a new form of money in the form of CBDC.

In the next part of the paper, we define CBDC about the three kinds of existing money and make a preliminary sketch of different kinds of CBDC design models. This leads to a discussion of the conventional monetary policy trilemma, which is normally applied to relations between different currencies. We adopt this trilemma to a domestic situation with multiple kinds of money denominated in the same currency.


The final part of the paper is an analysis of the monetary policy implications of each of the different CBDC design models. The adapted monetary policy trilemma is applied to three different scenarios, which are derived from the three different perspectives on money: the money user scenario, the money manager scenario, and the money maker scenario. The analysis considers issues of parity, interests, money supply, and sovereignty.

The paper ends with a conclusion summing up the results.