Jacob Wijngaard (RUG) Towards a monetary system with digital cash as backbone

The financial crisis of 2008 has raised doubts about the sustainability of the current monetary system. In the current system we generally use our demand deposit at some commercial bank to execute a payment. Such a demand deposit is a claim on cash. Cash itself is getting less and less popular, especially for larger transactions. That implies that the banks are very free  in generating extra demand deposits. The only limits come from the restrictions on solvability and liquidity. But these restrictions are only aggregate and rather light; the whole system is directed to letting the payment system function as smoothly as possible. The main concern with respect to the sustainability of the current system is the effect of the bank freedom in this system  to the boom/bust behavior of the economy.

An important change of the current system that is seriously considered by the international banking world is the introduction of digital cash. Cash is issued by the CB (Central Bank). It is a form of base money, equivalent to the reserves of the banks at the CB. If the CB issues (also) digital cash and creates a payment system that includes possibilities for efficient conversion of demand deposits to cash and vice versa, cash is getting much more attractive. The debate about digital cash (also called Central Bank Digital Currency, CBDC) concentrates on the question whether it does not destroy the current system. A broad and sudden conversion of demand deposits to CBDC is a modern bank run. Digital cash helps to keep the banks careful, but what frictions have to be built in to prevent that the economic actors switch too easily from demand deposits to CBDC? It is a delicate balancing act.

A more robust possibility is to transfer the payment function from the banks to the CB (or some related public institute), encouraging that all payments are executed by digital cash. This is proposed by the Positive Money movement in the UK and by similar movements in other countries. It has received some attention, but is not seriously explored. This is unfortunate, because such an innovation opens attractive possibilities, certainly when it is combined with the removal of (physical) cash.

These possibilities are explored in this seminar:

• If most transactions are settled by digital cash, it is possible to monitor real time a proxy of the nominal GDP. The interest rate on the digital cash accounts can be linked to this proxy. In this way it is possible to build in an automatic inflation correction.

• The banks are and remain important for granting credits. Credits are in digital cash. This cash is either provided by actors with superfluous digital cash or borrowed from the CB. In case of too much digital cash, the banks can buy bonds. By setting simple rules for borrowing cash from the CB and for buying and selling bonds it is possible to control the interest on credits.

• This leads to a whole new setting for monetary policy. In the current system it turned out to be impossible to stick to a rule based policy. But in this new setting it may be possible. A rule based policy instead of a discretion based one contributes to transparency and stability.

• Lining the interest rate to a GDP proxy necessitates labeling and monitoring of the transactions. It may be possible to define the labels such that the monitoring contributes also to the detection of criminal transactions and money laundering, without interfering too much with privacy protection rules.