The Bank of England has gotten a step closer to issuing its own cryptocurrency after concluding that digital cash could make it easier to guide the economy through monetary policy.
In a blog, BoE staff concluded that a central bank digital currency that is a close proxy for bank deposits may strengthen the transmission of monetary policy changes.
It could also make quantitative easing slightly more effective by by-passing the banking sector and avoiding some unwanted side-effects.
BoE is one of many central banks who are looking seriously at issuing a digital currency as they view the explosive growth in cryptocurrencies as a threat.
The way the staffers see it, the central bank digital currency (CBDC) will pay an interest on balances as well as offering payments services and would therefore compete more closely with bank deposits.
“This means there will be an impact on the volume and price of bank funding, with implications for monetary policy.”
However, CBDC accounts would not provide credit facilities which is why they would not be perfect substitutes for bank deposits.
Risk free rates
The idea is that the interest that the central bank pays on CBDC would act as a floor to all other rates in the economy.
“This is because it would both represent the safest store of value and also provide transactional services, so, in our model, no-one would lend to someone else, at risk, for less than they could earn by holding risk-free CBDC at the central bank,' the BoE said.
Deposit rates with commercial banks are typically below the policy rate.
“Other rates in the economy would then be above this CBDC rate, with the spread determined by factors like their relative transactional service, liquidity and risk.
“By varying the interest rate paid on CBDC, the central bank could move these other rates in the economy, either encouraging or restricting growth.”
Exiting the banks
The BoE research showed that universally accessible CBDC would represent an alternative option to bank deposits for those wanting to hold transactional balances risk-free.
This means if mean that if increases in the rate paid on CBDC were not matched by an equal increase in the rate paid on deposits, some people would move their deposit balances to CBDC.
Therefore, the BoE blog reckons banks would therefore need to react more quickly to changes in central bank policy rates, to avoid losing deposits to CBDC accounts.
“This would result in an increase in both the strength and speed of pass-through from the policy rate to these other interest rates especially since technology and regulation make it easier to switch balances from one account to another," the BoE reseachers argued.
“The funding costs of banks in our model then become more sensitive to changes in policy rates.
"All else equal, this would directly drive an increased sensitivity of lending rates to policy changes – interest rates on mortgages, loans and credit cards would move by more for the same change in the policy rate."
Universal CBDC inevitable
What's more, they go on to say, the ability of non-bank lenders to clear transactions across the central bank’s balance sheet would increase competition in lending, further increasing pass-through to lending rates.
The BoE staff have even suggested a way CBDC can be used to implement negative rates without the need to abolish cash.
According to Michael Cunningham, principle advisor at Adro!t Risk, the use of sovereign CBDCs and ultimately a universal CBCD is inevitable, the timeline for the latter not being that far away as most anticipate.
He claims success in how CBCD rate changes impact the real economy will depend on what proportion the CBDC is in relation to the total quantum of various financial means of exchange.
“The ability to impose negative interest rates would be particularly powerful for the efficacy of the monetary transmission - however, there are some potential 'big brother' implications in how this could be applied by central banks and governments."