18 April 2023

Project Syndicate's Buiter: The Overwhelming Case for CBDCs

There is growing evidence to suggest that, in the coming years, the US Federal Reserve and other central banks will find themselves back where they were before the pandemic, with their primary policy instrument constrained by the natural real interest rate. Fortunately, this old problem now has a prudent technological solution.

The natural real interest rate reflects the balance of planned savings and capital formation under the theoretical conditions of full employment and on-target inflation. True, nothing is ever certain in the real world. The larger government budget deficits become, the more upward pressure there will be on the natural rate. While aging societies tend to save more, truly old societies save less. And one also must consider the effects of a possible great “decoupling” of the global economy and the rise of US-centered and China-centered blocs.

That could well reduce capital inflows for the advanced economies, boosting their natural rates. Still, on balance, it is reasonable to assume that in two or three years, we will return to a world in which advanced-economy central banks’ nominal policy rates are regularly constrained by the effective lower bound (ELB). A zero nominal interest rate on currency (cash) sets a near-zero floor under the central bank policy rate. A very low natural real interest rate and low inflation make it likely that the ELB will be a binding constraint. Even though nominal policy rates have risen significantly since 2020, with the US Federal Reserve’s policy rate now at 4.75-5%, real (inflation-adjusted) short-term policy rates are still barely positive in the United States, and they remain materially negative in most other advanced economies. According to the Federal Reserve Bank of Cleveland, the US ten-year real interest rate was only around 2%, and that was its highest level since the 2008 financial crisis.

 If the Fed again faces a situation where the federal funds rate is constrained by the ELB, it will have lost its most effective instrument for providing stimulus to counter below-target inflation or excessive unemployment. Without being able to cut rates further, its only remaining tools will be quantitative easing (purchasing high-quality assets), qualitative easing (purchasing lower-grade financial claims), yield curve control (purchasing bonds of a certain maturity at whatever scale needed to keep their yields within a certain range), and forward guidance.

The good news is that the Fed (and other central banks) do have one other promising option: ditch the ELB altogether by abolishing cash and introducing a well-designed wholesale and retail digital currency that is widely available to the general public. With a central bank digital currency, setting the policy rate at -5% could be as easy as setting it at 5%....

 more at Project Syndicate

© Project Syndicate