CENTRAL BANK DIGITAL CURRENCY AS A POTENTIAL SOURCE OF FINANCIAL INSTABILITY.

• Author: Selgin, George

Various proposals for a central bank digital currency (CBDC) involve different technical solutions to as many distinct problems. My concern is with the monetary policy implications of those (e.g., Bordo and Levin 2019; Ricks 2020) that would allow anyone to place deposits in a Fed Master Account, directly or using ordinary banks as brokers.

A decade ago, I published a paper on "Central Banks as Sources of Financial Instability" (Selgin 2010) in which I argued that, notwithstanding conventional wisdom, central bank monopolization of paper money has been an important historical cause of financial instability. Here I wish to argue that central bank provision of digital money, and particularly of retail deposits, may also prove destabilizing.

"Old-Fashioned" Bank Runs

How could individual Fed accounts be destabilizing? Consider the case of a "classic" systemic financial crisis. This consists of a run, not on one or a small number of banks, but out of bank deposits and into central bank currency.

As every money and banking student learns, in a fractional-reserve system, every dollar of paper currency withdrawn from the banking system can lead to a much larger reduction in bank deposits and, hence, the total money stock. In principle, aggressive central bank expansion can keep the money stock from shrinking. But because central banks generally don't lend to private-sector borrowers, the substitution of central-bank-supplied paper money for bank deposits can't preserve the private credit that collapses along with the stock of commercial bank deposits. A serious "credit channel" bust can still occur.

Because stockpiling and transacting with paper currency is both inconvenient and risky, most bank runs have been runs from banks suspected of being unsound to others people still trusted. That's especially true in banking systems with nationwide branch networks, because most sizable communities in such systems have access to more than one commercial bank. Despite their notoriety, systemic runs have been rare. Indeed, they were so even in the pre-FDIC United States, which saw more than its fair share of panics (Schwartz 1987: 271-88). Even the nearly systemic run of February and March 1933 wasn't an exception, for it was not so much a banking panic as one informed by growing fears that FDR was planning to devalue the dollar (Wigmore 1987: 739-55). In other words, what looked like a general loss of confidence in U.S. banks was in fact a loss of confidence in the government's willingness to stick to the established dollar standard. (1)

Allowing for Fed Account Balances

Now let's consider the case in which, instead of facing two options--holding liquid claims against private intermediaries, or holding paper currency--people have a third option: they can place funds in their personal Fed accounts.

According to many of their advocates, private Fed accounts, besides being perfectly safe, will offer many of the advantages of ordinary bank accounts, and will be even cheaper to maintain. For example, in recent congressional testimony, Morgan Ricks (2020: 4) observes that, under his "FedAccount" proposal,

The Fed would charge no fees and would not impose any minimum balance requirements. FedAccounts would also have all the special features that banks currently enjoy on their central bank accounts: real-time payments, high interest compared with ordinary bank accounts, and full government backing with no need for deposit insurance. The FedAccount plan would, however, not allow depositors to overdraw their Fed accounts. That provision is necessary if the Fed is to avoid serving as a "lender of last resort" not just for banks but for anyone who can't balance a checking account. In normal times, this limitation might make personal Fed accounts seem less...