Research | Exploring the potential economic benefits and financial impact of central bank digital currencies

Source: China Social Sciences Today

Original title: "A Preliminary Study on Central Bank Digital Currency"

Author: Ji Yang, Bian Wenlong, Wang Peng

Recently, the news about the People's Bank of China issuing digital currency has attracted widespread attention. my country began to develop digital currency in 2014, earlier than most countries, and has been rapidly advancing in the past two years. Most countries in the world began to develop digital currency around 2017. There are three main driving factors: the first is the development of related technologies, which has enhanced the technical feasibility of digital currency; the second is the rise of mobile payments, which has gradually reduced the use of cash; and the third is the change in international trends, which has led to competition among countries in the field of digital currency. In 2019, the Bank for International Settlements conducted a survey of central banks in 66 countries around the world, of which 80% of the central banks stated that they were conducting relevant research on central bank digital currency, about 40% of the central banks have entered the experimental demonstration stage from the conceptual demonstration stage, and 10% of the central banks have launched pilot projects.

Central bank digital currency under technological innovation

Based on the types of users that central bank digital currencies target, the Bank for International Settlements divides central bank digital currencies into two categories: wholesale market central bank digital currencies and retail market central bank digital currencies. Wholesale market central bank digital currencies are targeted at financial intermediaries such as commercial banks, and ordinary residents cannot hold them. Representative countries that conduct research and development for wholesale markets include Canada and Singapore. Retail market central bank digital currencies are targeted at the retail market, and can be held by economic participants such as residents and non-financial enterprises. Their application is not limited to the wholesale market of funds, nor is it limited to financial institutions such as banks.

From the perspective of technical route, the central bank digital currency in the wholesale market applies blockchain-related technologies to transform the transaction mode of "digital account" accounting in the wholesale market into a "digital cash" mode, thereby improving the transparency, security and overall efficiency of payment. There are two technical options for the central bank digital currency in the retail market. One is the "central bank digital account" mode, which allows ordinary residents to open accounts in the central bank, and their account balances belong to the central bank's liabilities, so it is a digital form of central bank currency. The other is the "digital cash" mode, in which the central bank uses encryption algorithms to issue and circulate digital currency. Users do not need to verify the identity of the currency holder in the transaction, but only need to verify the authenticity of the digital currency itself like verifying the authenticity of banknotes.

In the above scheme, the "digital cash" model still has certain technical difficulties and requires technical research and development and related experiments to ensure its feasibility. The "central bank digital account" model is technically similar to the current account operation system of commercial banks, and its technical threshold is relatively low. The reason why this model still requires a lot of research and development work is that the central bank digital currency in the retail market has a large potential economic impact, creating opportunities for ordinary residents to directly use central bank funds, and providing a digital settlement tool with a legal currency status similar to cash, which will have a profound impact on the financial system and the macroeconomy. Therefore, central banks in various countries have carefully weighed their benefits and costs and reached different conclusions. For example, the Swedish central bank believes that the risks of central bank digital currency in the retail market are controllable and have significant advantages, so it continues to promote the issuance of central bank digital currency in the retail market; while the Danish central bank believes that the issuance of central bank digital currency in the retail market has greater risks than benefits, so it publicly stated that it will not issue central bank digital currency for the time being.

my country's central bank digital currency is a "digital cash" model for the retail market. This model of central bank digital currency has both technological innovation and potential economic impacts mentioned by other countries, so it is worth further analysis and research at the financial system and macroeconomic levels.

Potential economic benefits of central bank digital currencies

In the discussion about the central bank's digital currency, a common question is, the existing mobile payment system is already relatively developed, in what aspects will the marginal contribution of the central bank's digital currency be reflected, and whether it is necessary for the central bank to enter the mobile payment market. Based on the preliminary research of the People's Bank of my country and other central banks, the following potential economic benefits are worth paying attention to.

First, the central bank's digital currency helps maintain monetary sovereignty and legal tender status. In the retail market, cash is the only legal tender, but it is costly, inconvenient, and demand is gradually declining. The central bank's issuance of digital legal tender will help cope with digital social changes.

Second, the central bank's provision of mobile payment services will help enhance the competitiveness of the payment market. The payment market has obvious network effects and is prone to form a high market share under the natural selection of users. The intervention of the central bank's digital currency is intended to provide another means of mobile payment and limit the private payment platform from forming too strong a market force. In particular, the huge difference between the central bank and private platforms is that the central bank will not simply consider commercial interests and can pay more attention to social effects. As a government-related agency, the central bank directly participates in the competition in the payment market. If it wants to achieve the improvement of social welfare, it needs to ensure fair coordination of the license management of the payment market, maintain innovation according to user needs, jointly maintain the convenience of the current payment ecology, and avoid administrative monopoly behavior in the mobile payment market such as the Central Bank of Ecuador from 2014 to 2018.

Third, the central bank's digital currency helps maintain the inclusiveness and robustness of payment tools. Existing mobile payment tools rely on the coverage of mobile network signals and are difficult to use during natural disasters or in remote and poor areas. Both my country and the Swedish central bank mentioned the design of the central bank's digital currency "offline payment" function, which aims to provide payment services without network and signal and expand the boundaries of mobile payment. However, the Swedish central bank once pointed out that "offline payment" requires a carefully designed regulatory framework, and the risks borne by payers and payees can be controlled by limiting the number of transactions and transaction amounts in offline situations.

The financial impact of central bank digital currencies

In addition to the above potential advantages, central bank digital currency may also bring other impacts to the financial system and macro-finance, among which the most concerned are the "financial disintermediation" effect and the "cross-border spillover effect". Scholars from institutions such as the Bank of England, the European Central Bank, and the Norwegian Central Bank have discussed this and discussed possible response strategies.

There are two types of financial disintermediation that may be induced by central bank digital currency. The first type is called cyclical financial disintermediation, which means that when financial risks are high, residents may convert a large amount of their deposits into central bank digital currency. During a financial crisis, a large number of bank customers will go to the bank to withdraw cash, which is called a "bank run". In the era of cash, "bank runs" are completed by queuing at the bank door, taking numbers, and withdrawing cash in turn. When central bank digital currency replaces cash, "bank runs" can be completed through simple mobile phone operations, which is faster and more convenient, and may also cause greater shocks. The second type is called structural financial disintermediation, which means that under normal economic conditions, residents convert a large amount of current deposits or other payment account balances into central bank digital currency and hold them. This will reduce the source of funds for the financial intermediary sector, increase the central bank's liabilities to the resident sector, and thus affect the liquidity supply of financial intermediaries, mainly commercial banks, to the real economy, while increasing commercial banks' dependence on central bank funds. In order to reduce the entry risks that may be induced by central bank digital currency, scholars from various countries have proposed different solutions, including limiting the amount of transfers in and out of central bank digital currency accounts, setting an upper limit on the holding of central bank digital currency, setting negative interest rates for excess central bank digital currency, etc. However, so far, no solution has been generally recognized.

In addition, the central bank digital currency also has a "cross-border spillover effect", which means that the issuance of a central bank digital currency by a country may have an impact on other countries through cross-border capital flows. Take Denmark as an example. Its capital account is fully open and its exchange rate system is a fixed exchange rate. Once Denmark issues a central bank digital currency, its legal currency attributes and exchange rate stability attributes may attract investors from other countries. Coupled with the digital attributes of digital currency that facilitate transactions, Denmark's capital flows will be intensified. This is one of the main concerns of the Danish central bank about issuing digital currency.

Faced with the possible economic and financial impact of central bank digital currency, many countries have carried out relevant economic research earlier. Take the United Kingdom as an example. Although its central bank has no clear issuance plan so far, it publicly called on the academic community to analyze its macroeconomic impact as early as 2015, and emphasized that central bank digital currency is not a simple technical issue, it will affect the basic structure of the financial system. The macroeconomic structure and central bank digital currency design schemes of various countries are different, and it is difficult for my country to directly learn from the research conclusions of other countries. How will my country's central bank digital currency affect the financial system, and how should its economic benefits and economic costs be measured? Analyzing the above issues in combination with my country's national conditions and my country's design scheme is not only important at the theoretical level, but also urgent at the practical level.

(This article is a phased result of the National Natural Science Foundation of China general project "Research on global financial risk spillover and its management under the impact of major public health emergencies" (72073113))

(Author’s affiliation: School of Economics, Xiamen University; Sungkyunkwan University, South Korea; School of Economics, Xiamen University)