Tuesday , January 19 2021


I wrote an oped for Il Sole 24 Ore on central bank digital currency, as part of a series they are doing. It's here in their premium edition (gated) here on their blog, in Italian on top and English below. Thanks much to Luciano Somoza and Tammaro Terracciano for translation and inspiring the project.THE DIGITAL EURO ...

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I wrote an oped for Il Sole 24 Ore on central bank digital currency, as part of a series they are doing. It's here in their premium edition (gated) here on their blog, in Italian on top and English below. Thanks much to Luciano Somoza and Tammaro Terracciano for translation and inspiring the project.


A central bank digital currency (CBDC) is in principle a very good idea. It offers the possibility of very low-cost transactions to households and businesses, especially in securities and international transactions. More excitingly, CBDC offers us a foundation for an efficient and nimble financial system that is completely insulated from recurrent crises. 

But CBDC poses a puzzle, as it undercuts many of governments’ and central banks other questionable objectives. Central banks want to prop up conventional banks, who benefit from taking deposits. And governments are unlikely to want to allow the anonymity that is the great attribute of physical cash. 

One vision for CBDC basically gives everyone access to bank reserves. Reserves are interest-paying accounts that banks hold at the central bank. When bank A wishes to pay bank B, it notifies the central bank, which just changes the numbers in each account on the central bank’s computer. The transaction can be accomplished in milliseconds, and costs basically nothing. Why don’t we have that? We should.

Now, opening reserves to everybody, is not a practical idea. Central banks have no competence at the daily details of interfacing with millions of consumer accounts. If you lose your password, if you made a payment by mistake, if you overdraw your account, do you think the ECB  will answer the telephone, or even run a smooth website? Can central banks even begin to effectively implement their own regulations for consumer-facing financial services? Probably not. 

Thus, a practical CBDC really will likely be limited to a wide array of non-bank financial institutions, who then handle the consumer-facing details, for a small fee. But having stated it that way, we are essentially rediscovering narrow banks: financial institutions that take deposits and 100% back those deposits with reserves at the central bank, and provide high-speed electronic transactions services. 

Narrow banks are a wonderful idea, as they simply cannot fail, and they simply cannot suffer runs and crises.  If our regulators stipulate that all deposits must be in narrow banks, and regular banks must raise funds by selling equity or long-term debt, we would have a financial system forever immune from crises, and the regular banks would need next to no regulation. 

Why do we not have narrow banks already — either regular banks or money-market funds that offer debit cards? The paradoxical answer is simple: The same central banks and government regulators that are thinking about issuing CBDC ban narrow banks. 

They offer reasons, echoed by Lea Zicchino in a previous article in this series

First, people might run away from bank deposits in a crisis. But people, and more importantly financial institutions, already can run to cash, money market accounts, mutual funds, commercial paper, repo, and many other securities.  The heart of a run is what people are running from, not what they might run to. Substituting CBDC for bank deposits would stop, not enhance runs. 

Second if people hold more CBDC in place of bank deposits, then banks will lose a cheap source of funds, and they might raise lending rates. 

Now, any time you are asked to support regulation  that forces you to buy an overpriced (low interest rate) inefficient (slow and costly transactions) and fragile (prone to crises) product, so that an oligopolistic highly regulated industry may enjoy a lower cost of funds, that it will, supposedly, benevolently pass on to borrowers, you should be suspicious.  Perhaps that lower cost of funds goes mainly to bank shareholders and management! 

In fact banks can raise all the money they need by borrowing long-term, or by issuing equity. If our society wishes to subsidize bank lending, let us do so directly and on budget, not by forcing us all to hold inferior products. 

A second vision for CBDC, inspired by cryptocurrency, views it as a substitute for cash. The electronic infrastructure for cryptocurrency is different, and less efficient, but the financial structure of a backed central bank digital coin is the same as reserves for all. Viewed as 21st century cash, however, we do not expect the level of service that an account suggests. Forget your password, get swindled, and the money is gone, just as lost cash is gone. (Elon Musk reportedly forgot his password and lost $100,000 of Bitcoin. Too bad.) 

That vision could be provided directly by the central bank, more realistically than opening reserves to all. And many economists (not me, but an argument for another day) wish to get rid of cash, so that the central bank can implement deeply negative interest rates.

But anonymity is one of the central attributes of cash. Nobody knows how much of it you have, and nobody watches your transactions. The challenge of cryptocurrencies like bitcoin is that they offer anonymous transactions. If central banks want to displace currency, are they really =willing to allow completely anonymous transactions? 

A not-so-hidden motivation  for CBDC is to crack down on illegal transactions. But if any country, especially Italy, put a stop to all illegal transactions, its economy would come to a screeching halt. Imagine if every tax had to be paid, every informal worker fired or made legal, including every housecleaner and nanny, every transaction available for legal scrutiny? Cash is an important escape valve for idiotic regulation and stifling taxes. 

And imagine the loss of our political freedom if every transaction is written down somewhere and available for legal investigation or just embarrassing leakage. Privacy in transactions is one of the essential rights of a free society. 

But widespread tax evasion, mafia, bribery, and illegal activity is also bad for the economy and society. Cryptocurrencies are the favorite of hackers and ransomware thieves. 

Cash achieves a rough balance, just inconvenient enough to limit its bad uses, just private enough to allow some escape valve. 

We have a dilemma. Will CBDC allow full privacy? Then it will be much more efficient for all the bad illegal uses. Will CBDC transactions be visible to regulators and tax authorities? Then it will crush the economy. Can a CBDC be constructed that offers some privacy, even for formally illegal uses, but in which authorities can enforce massive tax evasion and truly illegal activity? 

That is the hard problem which our societies will have to address. It argues, I think, for digital currencies backed by central bank reserves, but operated by independent private financial institutions, who can effectively guarantee some forms of privacy and require standard protections of law before governments see the data. But achieving that balance will require the loud insistence by ordinary voters and privacy advocates on solid protections of their transaction privacy, which power-hungry governments and bureaucrats are not likely to allow on their own. 

It also argues that CBDC will force governments to reform idiotic economy-killing taxes and regulations, especially labor regulations. That’s not so bad either. 

CBDC, and its financial equivalents of narrow banks and private cryptocurrencies fully backed by central bank reserves, are no more than currency, updated to 21st century technology. Currency was a great invention. Banks used to issue currency, leading to crises. In the 19th century governments issued currency, which proved much more risk free and immune from runs. Banks were able to fund lending by other means. 

By all means let us update currency to be safer, faster, electronic, and pay interest.  We have little to fear financially, and much to gain from CBDC. Banks may lose their subsidy, and governments will have to face squarely the value of transactions privacy, and reform their taxes and regulations so that enforcement will not tank their economies. Both are added benefits, not costs. 


John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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