Why a central bank digital currency could be an inflation-fighter's best friend
Digital money allows flexibility that could prove to be invaluable, Ethan Lou writes.
I'm not one to say that Canada must have a central bank digital currency. The privacy implications alone are concerning.
But the Conservative leadership candidate Pierre Poilievre's recent central bank bashing gives rise to an interesting idea about the potential benefits of such a currency in terms of monetary policy.
Perhaps a little over-passionately, Poilievre has been criticizing both the high inflation under current Bank of Canada policies and the idea of a CBDC, something he said he would outlaw if he were to eventually become prime minister.
But what if the latter could be the solution for the former?
We don't yet know what precise form a CBDC could take, or even if such a currency would replace cash, exist alongside it, or displace current electronic forms of payment. Not even China, the front-runner in the game, has done any large-scale testing.
But considering such a currency at its most basic level — a digitized, programmable form of money — it is easy to see that it has the potential to alleviate what has long been the biggest problem of monetary policy: that it is a blunt instrument.
While the current bout of inflation has complicated origins, with many factors, a lot of blame has fallen on central banks, whose economic levers often have widespread effects that are difficult to predict and measurable only in the aftermath. Critics say the banks had gone too far one way by overstimulating the economy amid the pandemic.
A central bank digital currency theoretically allows for micro-targeting — perhaps by sector, perhaps by region, perhaps by socio-economic class — with real-time feedback, and that could be invaluable the next time the economy needs stimulating.
The disruption in advertising markets is a good comparison. Companies used to target only specific broadcast hours or print publications based on the broad hope that the type of customer they wanted were tuning in or reading, and that was about it. Facebook upended the game by letting companies advertise directly to hyper specific groups — mid-20s recent immigrants on the suburban West Coast who like board games, for example.
While we would probably never get that specific with a CBDC, it would be the same general idea.
There's a Bank of Canada research paper on this very thing: “A CBDC can allow for different interest rates on different balances or on different types of accounts ... This flexibility can help central banks implement monetary policy more effectively.”
Geoffrey Yu, a Bank of New York Mellon Co. senior strategist, has gone further and written that the ground-level pandemic stimulus cheques could also have been more efficient with a CBDC.
When the government hands out money to people, Yu writes, “the CBDC wallet application can be programmed in a way such that funds contained within can only be spent in designated areas and also have a certain expiry date ... Stimulus could therefore be skewed toward helping a designated sector.”
It is true a lot of that is already somewhat possible without a digital currency. Singapore, for example, gave out S$320 million in vouchers amid the pandemic that could be spent only on the local tourism sector.
The issue, however, is time. Even if the government didn't have to co-ordinate with the tourism sector, simply giving everyone US$1,200 like the U.S. government “still required legislation, additional scrutiny, and co-operation with commercial banks, among other cumbersome procedures,” Yu writes.
And then you don't know whether such efforts have been too little or too much until months down the line, when the data gets back through layers of organizations. Quantitative easing and the lowering of interest rates have the same kind of limitations — which is one of the main reasons the economy is in the mess it's in.
It isn't necessarily the Bank of Canada's fault.
It's just that, even with all the models in the world, the economy is still what theorists would call a game with incomplete information.
So, back to the advertising analogy: Another game-changing feature of digital campaigns was the near-immediate feedback, letting companies fine-tune their techniques in real time. That is what a central bank digital currency could do.
A lot of that might blur the line between monetary and fiscal policy. It might involve expanding the role of the Bank of Canada or moving it closer to the government's executive branch, beyond what some are comfortable with.
But there's no one mould for this. The current idea of inflation targeting, for example, was pioneered only in 1990. Monetary policy has been constantly evolving, and so might the role of the central bank.
And, as the former Bank of Canada governor Stephen Poloz writes in his new book, The Next Age of Uncertainty, the future might look a lot more turbulent, straining the capacity of current policy tools.
In that context, there certainly are merits to thinking outside the box a little.