How Politics Affects the Fed’s Design of a Digital Dollar
According to the Chairman of the Federal Reserve Jerome PowellJerome PowellFed’s Bowman opens door for bigger rate hike in March Manchin: White House acknowledges inflation is major concern, the Fed will not issue public digital currency without congressional approval. But within Congress, there are competing visions for the design of public digital currency.
The “Banking for All Act”, sponsored by the senator. Sherrod BrownSherrod Campbell Brown White House slams GOP for blocking Biden’s Fed nominees amid inflation Psaki calls Republicans ‘irresponsible’ for blocking Biden’s Fed nominees Senate leaders send to Putin a symbolic warning shot amid invasion fears MORE (D-Ohio), requires Federal Reserve Banks to make public digital currency accounts freely available to everyone. An alternative bill, sponsored by Rep. Tom EmmerThomas (Tom) Earl EmmerMinnesota Court Brings Changes to House Democrat On The Money District Lobbying World – Breaking January Jobs Boom MORE (R-Minn.) Prohibits Federal Reserve banks from directly issuing digital currency to the public. If the Fed decides to issue it, the ultimate design of a Fed digital dollar may well depend on which party controls Congress.
The Fed issues two forms of central bank money: Federal Reserve paper notes and digital dollars held as reserve balances in primary accounts at Federal Reserve banks. These can only be held by banks and other specialized financial institutions. A new public digital currency would allow the public to own Fed digital dollars. There are many ways to design a public digital currency, if issued, and this design could have broad implications for the financial system.
Brown’s bill requires Federal Reserve District banks and member banks to offer a new type of public digital currency account free of charge to the public. These “digital wallets” called “FedAccounts” would hold digital Fed dollars, pay interest, and provide all the services typically associated with a full-service business bank account — a debit card, ATM access, and services. Electronic bill payment – no minimum or maximum balance requirements. The bill requires large banks to absorb the cost of offering FedAccounts while banks with less than $10 billion in assets would have their operating costs reimbursed by the Fed.
Emmer’s bill prohibits Federal Reserve Banks from offering products or services to individuals, which would prevent FedAccounts. According to him, this restriction will ensure that public digital currency, if issued, offers privacy and services that mimic private stablecoins. According to Emmer, “everything [public digital currency] implemented by the Fed must be open, permissionless, … accessible to all, transact on a blockchain transparent to all and maintain the confidentiality elements of cash.
Notwithstanding Emmer’s design preferences, his bill does not need to require a public digital currency to be a blockchain token. Public digital currency could be issued using specialized accounts at depository institutions that have primary accounts at the Fed. These account balances would be matched dollar-for-dollar with separate reserves deposited by the depository institution with a Federal Reserve Bank. This form would not necessarily be exchanged over the Internet, but instead could use the existing infrastructure of the bank payment system. Indeed, the recent Federal Reserve Bank of Boston MIT study tested such a design.
Perhaps the most important design feature of a public digital currency is its ability to pay interest. Free FedAccounts that pay positive interest would be extremely popular. Paper money earns no interest, so a public digital dollar that is a direct substitute for money shouldn’t either. Few with large digital Fed dollar balances pay negative interest if there are cash and positive-yielding alternatives. A public digital currency that pays positive interest will easily dominate cash and private stablecoins, as most stablecoins do not pay interest or dividends to avoid Securities Exchange Commission registration and reporting requirements.
Congressional views on the design of public digital currency reflect differences in legislative priorities. However, legislative proposals that seek to make them free and universally available to improve financial inclusion or, alternatively, restrict their design to ensure privacy, ignore evidence that the design of public digital currency may not be the best way to achieve either of these goals.
The past decade has seen a marked decrease in the problem of the unbanked. According to the FDIC, “the proportion of U.S. households that were unbanked in 2019 — 5.4% — was the lowest since the survey began in 2009.” Additionally, the FDIC found that “about half of the decline in the unbanked rate…was associated with improvements in the socioeconomic status of American households….” Any benefits that would accrue to the unbanked from the Banking for All Act would likely be outweighed by the costs it would impose on others by depressing economic growth. This conception of public digital currency would stifle economic growth by draining deposits from the banking system, thereby reducing the availability and increasing the cost of bank credit.
Similarly, banning FedAccounts for privacy reasons ignores the fact that, even without them, the government has been able to limit the access of targeted businesses and citizens to bank credit and the payment system, even when the transactions of the targeted individuals were perfectly legal. For example, during Operation Choke Point, the Department of Justice and the FDIC pressured banks to end their relationships with completely legal businesses such as check tellers, payday lenders, ammunition and gun dealers, and adult entertainment venues, as these businesses were disadvantaged by the Obama administration. . Banks were forced to terminate relationships on the grounds that these companies posed “high risk” and created “reputational risk” for FDIC-insured banks.
Recent historical events show that legislative goals such as providing financial services to the unbanked or protecting financial system access and privacy are unlikely to be best achieved by restricting the design of public digital currency. These political concerns are best addressed outside of this debate.
If passed, either of these legislative proposals will shape the design of public digital currency. This design has far-reaching implications, including on the availability of bank credit, the size of the Fed’s balance sheet, and the development of new payment system technologies. Designs should not preclude private sector payment system innovations that maintain the current level of transaction privacy and promise to improve access for those who are currently unbanked. It would be short-sighted to legislatively restrict design to meet a narrow set of policy objectives or to inhibit private sector innovation.
What is clear is that public digital currency design preferences are divided along party lines. Since the Fed has yet to seek approval to issue digital dollars, congressional scrutiny is potentially the most important factor influencing their design.
Paul H. Kupiec is a Senior Fellow at the American Enterprise Institute (AEI), where he studies systemic risk and the management and regulation of banks and financial markets.