Central Bank Digital Currency as a Monetary Policy Tool

While the Federal Reserve is trying to decide whether to recommend that Congress authorize creating a central bank digital currency (CBDC) for the United States, many other countries have already committed to creating their own CBDCs to avoid having their currencies replaced by Facebook’s Diem or some other stablecoin that has established or will establish strong financial networks. Dubbed “FedAccounts,” a Federal Reserve CBDC would provide a basis for a new return-on-savings monetary policy tool.

To serve as a tool for monetary policy, a Federal Reserve CBDC would need to be account-based (“FedAccounts”) as opposed to token-based. To protect individual privacy, while still deterring criminal behavior, the names and identifying information of account holders (including some personal transactions) would be kept in a separate file from their general transaction histories. The two files would be linked by a 60-digit alphanumeric code. If authorities observed suspicious activity in the general transaction histories, they would need a judge’s permission to access the corresponding identifying information file.

In addition to the 60-digit alphanumeric code, the transaction histories file would contain a single-digit yes-or-no dummy variable indicating whether this account had an associated Social Security number. This would be important, because only accounts with an associated Social Security number could earn a high positive interest rate during an inflation and that positive interest rate would only apply to a base amount of no more than $10,000. If $12,000 were in an account with a Social Security number, only the first $10,000 would earn the high positive interest rate, while the remaining $2,000 would be subject to a negative interest rate, as would all the money in accounts without a Social Security number. Anyone in the world could use US dollars to create their own US Federal Reserve “FedAccount.” People in Zimbabwe or Venezuela experiencing very high inflation in their local currency may be glad to pay a small or modest negative interest rate for the security and safety of holding their money as US dollars in FedAccounts.

To stop inflation the Federal Reserve has been raising the cost of borrowing, which suppresses supply as well as demand. Businesses that can’t afford the higher cost of borrowing may have to cut hours, lay off employees, or close outlets. Lower income people are generally the ones with the most debt so they get hit the hardest when the cost of borrowing goes up. If the economy slows because of the rate increase, it is the lower income people who are most likely to be unable to make their mortgage payments and lose their homes to foreclosure.

The current world-wide inflation is due in large part to the COVID-19 supply disruptions which are continuing. We have forgotten when we had to absorb excess demand to fend off inflation in the face of the mother of all supply disruptions at the beginning of World War II. We suddenly had to transition from civilian cars and trucks to tanks, armored personal carriers, warplanes, and warships. We also had to send a lot of our young, male workforce overseas to fight the Nazis in Europe and Imperial Japan in Asia. We needed a way to absorb a lot of money that would otherwise go to consumer demand to ward off inflation. We did it with “Liberty Bonds.” Celebrities were singing and dancing in promoting “Liberty Bonds.” Billboards and radio broadcasts were intensely advertising “Liberty Bonds.” By the end of he war, about 50 percent of American families had purchased “Liberty Bonds.”

It would be great if we could do the same with U.S. Treasury Direct Series-I bonds. For six months ending October 31, 2022, the 30-year I-bonds were paying 9.62 percent interest. Beginning on November 1, 2022, I-bonds are now paying 6.89 percent interest. A major problem preventing I-bonds from absorbing excess demand to stop inflation is the severe withdrawal restrictions that I-bonds currently enforce. No withdrawals are allowed for the first year, and there is no secondary market for I-bonds. Withdrawals after the first year are heavily penalized up until the end of the fifth year. This does not work for marginal savers who need immediate access to their money in case of an automobile accident, a medical emergency, an unexpected increase in rent, or a job loss. Yet it is the marginal savers with relatively high marginal propensities to consume who can stop inflation by saving their money to reduce excess consumer demand.

An alternative approach would have been the postal savings accounts that existed under “The Postal Savings Act of 1910” where for 56 years from 1911 to 1966 anyone could go to any post office in the United States and set up a savings account. The amount of money allowed in these accounts was severely restricted so it was aimed at people with only small amounts of money to save. But, again, the marginal savers with relatively high marginal propensities to consume are the very ones we want to influence to save more and spend less. If these postal savings accounts still existed, they could be used to absorb excess demand to stop inflation without causing a recession by offering a very high interest rate and heavily advertising them.

To make these accounts as attractive as possible to lower-income people, any interest earned in the new CBDC “FedAccounts” should be tax free. Every baby born in the United States should be assigned a Social Security number and a FedAccount at birth with $1,000 put in it, which could not be withdrawn until age 70. However, any interest in the account could be withdrawn at any time along with any additional money put into the account. This would make these CBDC accounts as attractive as possible. With everyone having a FedAccount, whenever someone cut your grass, mowed your lawn, or shoveled your snow, you could pay them instantly with a smartphone to smartphone transfer from your FedAccount to their FedAccount.

Finally, when an economic downturn comes, the Federal Reserve can use the FedAccounts with Social Security numbers to offer small low-interest-rate loans and give stimulus money directly to the people on Main Street to stimulate the economy as necessary instead of going through the New York financial markets on Wall Street. This new monetary policy CBDC tool would provide the Fed with more bang for the buck in controlling our economy more efficiently and more effectively in avoiding both recessions and excessive inflation.

( Note: Economists at the Bank of England have asked me to present my paper entitled: “New Central Bank Digital Currency (CBDC) Monetary Policy Tool” in their Bank of England session at the American Economics Association Conference in New Orleans on January 8, 2023. If you would like to see the abstract (“View Abstract”), the PowerPoint slides (“Presentation”), or the paper itself (“Preview”), you can find them at this link: https://tinyurl.com/2wr39xak )

Larry => be sure to go into html mode in MailChimp to hyperlink both this tinyurl and the link to this ND Economist commentary.

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