The financial system of tomorrow

Will digital currencies make it possible to create digital cash? What are the macroeconomic consequences of an alternative method of payment?

In 2017 Bitcoin and other digital currencies rose dramatically in value. Digital currencies are issued by private persons, hence there is no coverage if your Bitcoins are lost. Furthermore, there is no financial institution that are ensuring price stability on Bitcoins. As a result the value of Bitcoins is highly volatile. Therefore Bitcoins are not a fully reasonable alternative to physical cash or electronic bank money.

Physical cash

Physical cash are issued by the central bank in order to ensure price stability. In almost all countries the central bank has a monopoly on issuing banknotes. Therefore, digital cash should, with the current laws, be issued by the central bank.

Electronic bank money

Electronic bank money works as an IOU towards a given bank. An IOU is a claim toward an institution. When you deposit money into your bank account, the bank issues an IOU in return. The bank now lends your money to another person or company, and the money that was represented by physical cash before is now represented in multiple IOU’s issued by the bank. That means the bank has created more money.

The ability to create money is a significant aspect of modern commercial banks. One of the downsides with electronic bank money is the risk of losing them, which would happen if your bank goes bankrupt, since your IOU towards that bank becomes worthless.

Central Bank issued digital currency

The Nobel laureate James Tobin suggested in 1987 that:

“… the government should make available to the public a medium with the convenience of deposits and the safety of currency, essentially currency on deposit, transferable in any amount by check or other order.”

If the Central Bank issued digital cash it could have the properties that Tobin wanted. In 2016 the Central Bank of England issued a working paper, where the authors examined Tobins method of payment;

“In short, we imagine a world that implements Tobin’s (1987) proposal for “deposited currency accounts.”

Future prospects

In the last 5-10 years Central Banks all over the world, including Bank of China, Sveriges Riksbank, Bank of Canada and Danmarks Nationalbank have examined the possibility of a Central Bank issued digital currency (CBDC).

Although it would be great to have means of payment, as presented by Tobin, there are technical challenges that have to be overcome. Furthermore, there are several macroeconomic aspects, including the possibility to lower the zero bound limit and include digital contracts in transactions that would be affected by CBDC, thus we call for extensive research on the topic before an eventual introduction of CBDC.

Interested?

If CBDC has your interest we would love to see you to our event on this topic, which you can find here.

The rest of our articles is free to read here.

Sources: Bank of England, James Tobin & Danmarks Nationalbank