Federal Reserve economists Francesca Carapella and Jean Flemming released a new report on November 9, 2020, exploring the potential impact of a digital dollar on commercial banking and monetary policy.
The report entitled 'Digital Central Bank Currency: A Literature Review' provides a theoretical basis for understanding how central banks could influence consumer adoption and overall financial stability of the U.S. economy.
Digital central bank currency is the digital form of paper money. CBDC is a high-security digital instrument; like paper banknotes, it is a means of payment.
The Federal Reserve System is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of financial panics (in particular the 1907 panic) led to the desire for central control of the monetary system in order to alleviate financial crises.
In August 2020, the Fed published an original research paper comparing CBDCs (Central Bank Digital Currency) to other payment methods. In this paper, authors Paul Wong and Jesse Leigh Maniff estimated that a CBDC would never be able to fully replicate cash (fiat money).
Facebook's Libra project raised fundamental questions about legal and regulatory safeguards, financial stability and the role of money in society.
The goal was therefore to find a way for the central bank to use digital currency and block currency to launch its digital dollar. Governor Lael Brainard pointed out that the previous experiments had been successful. He said in the research document:
'Digital currencies, including digital central bank currencies (CBDC), present opportunities but also risks related to privacy, illicit activities and financial stability. »
The Federal Reserve has therefore conducted research and experimentation related to blockchain technologies and cases of potential use of digital currencies.
As part of this research, central banks have explored the potential of innovative technologies to provide a digital equivalent to cash in order to assess the opportunities and challenges of a CBDC, as well as its use cases, as a complement to cash and other payment options.
In other words, the objectives were:
- To evaluate the security and efficiency of digital money systems,
- Enlighten the understanding of private sector arrangements; and
- To give practical experience to understand the possibilities and limitations of possible technologies for digital forms of central bank currency.
In September 2020, the President of the Federal Reserve Bank of Cleveland, Loretta J. Mester, presented the Fed's work on digital currency to the country's central bank (CBDC) during a speech at the 20th Anniversary Chicago Payments Symposium.
A symposium is a meeting of specialists (philosophers, scientists, etc.) devoted to exchanges on a particular topic.
In her speech, she said that the leaders involved were 'developing and testing a series of distributed registry platforms to understand their potential advantages and disadvantages.
Ms. Mester explained the need to recognize and address concerns related to: 'Financial stability, market structure, security, privacy and monetary policy.
She stated that 'financial stability, market structure, security, privacy and monetary policy concerns need to be recognized and addressed:
'Other proposals would create a new payment instrument, digital cash, which would be exactly like the physical currency issued by central banks today, but in a digital form, potentially without the anonymity of physical currency'.
Mester also spoke about the effects of the pandemic and how it has ravaged the economy by disrupting the country's most important infrastructures, including the payments industry. She drew attention to the specific impact on the payments sector, i.e. the massive changes in the volume of national transfers.
She explained that some conceptions of the digital dollar allow the central bank to issue CBDCs directly to the end-users' portfolio using transfer and reimbursement services facilitated by the central bank, without the intervention of commercial banks.
However, Loretta Mester had clarified that these experiments are intended to explore the costs and benefits of CBDCs, which does not mean that the Federal Reserve intends to adopt such a currency:
'An experiment such as this one is an important ingredient in assessing the benefits and costs of a digital central bank currency, but does not signal any decision by the Federal Reserve to adopt such a currency'.
One of the objectives of the FED is to understand consumers' payment choices. The CBDC would expand the range of payment and savings options available to households. In the paper, economists hope to identify the 'intrinsic' value factors of a digital dollar, which is a critical issue to address going forward.
The authors of the research stated in the paper:
'From a theoretical perspective, the introduction of digital central bank currency (CBDC) raises long-standing questions about the provision of public and private money [...] and the ability of the central bank to use the DBCM as a means of transmitting monetary policy directly to households'.
Federal Reserve Chairman Jerome Powell believed that resolving privacy and security risks was much more important in this regard.
'As with any new literature, many questions remain. We think the most crucial question is what intrinsic characteristics of the CBDC as a means of payment and store of value are important for household portfolio choices about how much money to use'.
A literature review is essentially an environmental scan on a particular topic that serves to justify the need for further research.
However, the FED has indicated that although the CBDCs have been described as the central banks' 'arms race' of the decade, issuing the first CBDC does not seem to be the US priority.
While the U.S. Federal Reserve is not yet ready to adopt the digital dollar, it is clear that U.S. research on digital central bank currencies has shown the potential of blockchain technology to provide a digital equivalent of cash. The US is in no hurry to win the race for the CBDC, but they are in.
Written by Laetisia Harson
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