The financial crisis triggered by Covid-19 is exceptional on all measures. What makes it even more so is its timing with respect to what central banks can do.
Due to the protracted nature of the 2008 global financial crisis, the world’s most powerful money-printing institutions were already at the limits of unconventional policy when this crisis struck. That has prompted a debate about what central banks can do to help.
As a result, a lot of outside-the-box thinking that might have been seen as hare-brained or extreme has gained legitimacy. This includes the idea that some form of digital stimulus or central bank digital currency (CBDC) could help central banks push further beyond the boundaries of conventional policy.
Blue sky thinking should always be encouraged. Yet it is important not to rush out radical monetary transformations that have not been properly tested or scrutinised for unintended consequences. This has not stopped many influential names from pitching digital solutions as part of the crisis response.
The most high profile of these is Democratic Congresswoman Rashida Tlaib, who this month put together a policy proposal for an “Automatic Boost to Communities Act” that would distribute cash payments to US citizens by way of pre-paid digital cash cards. Ms Tlaib proposed that a $2tn programme be funded by the US mint producing two $1tn platinum coins, which would then be sold to the US Federal Reserve in exchange for equivalent cash liquidity. Her bill also proposed that these emergency cards be converted into a permanent Treasury-managed digital public currency wallet system.
Meanwhile, an early version of the alternative $2tn Coronavirus Aid Relief and Economic Security (CARES) act, which passed last week, considered rolling out Fed-managed digital dollar wallets to all US residents, citizens and businesses to facilitate cash distributions. Although excluded from the final bill, the idea could reappear in future packages if the US stimulus is expanded.
The Bank of England has added further legitimacy to the idea. In a March 12 discussion paper, it noted that such digital currencies could help central banks push beyond the constraints of monetary policy — such as the fact that cash does not pay less than zero interest. The BoE said that a CBDC remunerated at negative rates would “theoretically widen the policy options available and avoid the economic costs of having monetary policy hit the effective lower bound, potentially improving economic outcomes”.
Some privacy advocates fear a CBDC could be combined with a digital identification system to help governments in the battle against coronavirus by facilitating contact tracing as well as immunity and vaccine tracking.
In China, such identity systems have already been rolled out on mobile phone apps to help the government manage reinfection rates, and have proved highly effective. It remains to be seen if they can be anonymised enough for use in countries with personal privacy laws. But even the likes of China are yet to combine such tracing systems with the CBDC already in development.
Either way, government surveillance is a real concern. Apple’s digital dominance already makes it hard for consumers to decline privacy compromises terms in exchange for access to its products. Imagine how much harder that choice would be if the consumer had to sign up for a data-tracking CBDC, or waive her right to a government-funded handout or vaccine?
The bigger concern for me is whether CBDCs might inhibit our return to market-based systems once this period of state intervention and de facto nationalisation ends, due to the effect it has had central bank balance sheets.
Rushing out an untested economic cure without evaluating its potential long-term side-effects is as inadvisable for financial remedies as it is for medical vaccines against the disease itself.