201812

December 4, 2018 9:33AM

Central Bank Digital Currency Threatens Financial Privacy and Economic Growth

Various proposals for “central bank digital currency” (CBDC) have been under discussion for several years now. The central bank of Ecuador launched a digital currency in 2015 — and shut down the failed project three years later. A number of economists have addressed the topic.

What is a CBDC? It is a payment medium that would be denominated in the established fiat money unit, not in any new unit. There are two main models: (1) a digital token that, like traditional coins and currency notes, and like Bitcoin, passes peer-to-peer without going through the interbank clearing system, presumably validated by a distributed-ledger blockchain system; and (2) account balances that individuals and businesses can directly hold on the books of the central bank, retail versions of the balances that commercial banks presently hold there for interbank payments. The latter model is not really properly called a currency, being a deposit-transfer system, but it is put under the “digital currency” umbrella because it resembles fiat currency notes in being a liability of the central bank, and as such a “final” means of payment, and because transactions would settle nearly instantly on a single balance sheet.[1]

The debate over CBDCs was recently revived by the IMF’s Managing Director Christine Lagarde in a speech suggesting, rather tentatively, that central banks should consider issuing some kind of digital currency so as to keep up with the times. (Why on earth the IMF continues to exist, long after the demise of the Bretton Woods system that it was created to support, is a question for another time.)

Lagarde begins her speech with a potted history of money. Although she does not attribute the origin of money to the state, she suggests that the state helps to improve money. Once bank-issued money arose, “spearheaded by the Italian bankers and merchants of the Renaissance,” trust in the issuer became important. Thus: “Trust became essential—and the state became the guarantor of that trust, by offering liquidity backstops, and supervision.” The timeline matters here. In fact, Italian bankers began providing money payments via transferable account balances some time before 1200 AD, whereas European states provided nothing in the way of “liquidity backstops, and supervision” until many centuries later. So state guarantees were not essential to the spread of bank-issued money historically. Nor was the popularity or safety of private banknotes, as issued by 17th century London goldsmiths, or by 18th and 19th-century Scottish or Canadian bankers, historically dependent on state guarantees.

Lagarde rightly notes that “the fintech revolution … questions the role of the state in providing money.” She points to the recent proliferation of digital private payment providers “from AliPay and WeChat in China, to PayTM in India, to M-Pesa in Kenya” and namechecks “cryptocurrencies such as Bitcoin, Ethereum, and Ripple.” She expresses her own position on the desirable monetary role of the state in surprisingly tentative language: “Some suggest the state should back down. Still, I am not entirely convinced. … I believe we should consider the possibility to issue digital currency. There may be a role for the state to supply money to the digital economy.”

On the plus side of the CBDC ledger, Lagarde proposes that a central bank digital currency “could satisfy public policy goals, such as (i) financial inclusion, and (ii) security and consumer protection; and to provide what the private sector cannot: (iii) privacy in payments.” Wait, what? It is of course laughable that a government would itself provide greater privacy in payments than it allows private institutions to provide. Could this have been a joke intended to lighten the mood of the speech? The private sector can in fact provide as much financial privacy as customers desire, as numbered Swiss bank accounts once did, and as “privacycoin” crypto projects today remind us. Lack of privacy stems from government restrictions, not from private-sector inability.

Lagarde says that “There may be scope for governments to encourage private sector solutions” to the problem of financial inclusion “by providing funding, or improving infrastructure.” More effective ways to encourage private sector solutions to banking the unbanked would be (a) deregulation, especially not requiring permission for innovations in mobile and other payment platforms, (b) guarantees not to interfere in private payment platforms once launched, and (c) guarantees on the privacy of private sector accounts from government surveillance, which might help to attract some of the warily unbanked to deposit use.

To her credit, Lagarde recognizes that people value the privacy provided by currency: “Cash, of course, allows for anonymous payments. We reach for cash to protect our privacy for legitimate reasons: to avoid exposure to hacking and customer profiling, for instance.” But she is vague at best, and dissembling at worst, on how deposits on the central bank’s books would insure privacy. She promises that customer identities “would not be disclosed to third parties or governments unless required by law,” but adds: “Anti-money laundering and terrorist financing controls would nevertheless run in the background. If a suspicion arose it would be possible to lift the veil of anonymity and investigate.” Would any suspicion by a policeman or tax collector be enough to lift the veil? If so, then the CBDC would be no more private than ordinary current-day bank deposits. J. P. Koning not unfairly characterizes what Lagarde offers as a “Faustian bargain”: “The state will issue digital currency that protects us from information snoops in the private sector, on the condition that it gets a back door.”

In the US and Europe, at least, banks today are required to notify regulators of large or “suspicious” deposit and withdrawal activities, and are expected to surrender account information to the authorities on a written request, without a court order or a search warrant.[2] It is hard to imagine that any government would instruct or allow its central bank to create accounts with greater privacy protection against the national government than commercial bank accounts have.

In the background to Lagarde’s speech is a November 2018 IMF staff discussion note on CBDC that she cites. [3] The note itself does not offer a brief for CBDC, but rather enumerates plusses and minuses. Comparing CBDC to cash, demand deposits, and non-bank private digital payment media, the note’s authors find that “CBDC would not strictly dominate any of these alternative forms of money.”

The staff discussion note emphasizes the hope of Keynesian macroeconomists that “interest-bearing CBDC would eliminate the effective lower bound on interest rate policy,” but points out that it would have this effect “only with constraints on the use of cash.” It is the abolition of easily stored cash that allows a central bank to impose negative interest rates, not the introduction of CBDC in either form.

The IMF note acknowledges a case for stronger payments privacy:

There are legitimate reasons people may prefer at least some degree of anonymity—potentially when it comes to everyone except the government, and regarding the government unless a court order unlocks encrypted transaction information. It is a way to avoid customer profiling—commercial use of personal information, for example, to charge higher mortgage rates to people who purchase alcohol. Another advantage of anonymity is limiting exposure to hacking. Moreover, anonymity is often associated with privacy—widely recognized as a human right (as stated in the Universal Declaration of Human Rights [Article 12] and elsewhere).

The note also observes that a central bank offering retail deposits “could increase risks to financial intermediation. It would raise funding costs for deposit-taking institutions.”

Just as importantly on the minus side, although not mentioned in either Lagarde’s speech or the IMF staff note, is that diverting deposits from commercial banks to the central bank will shrink the funding for the economic-growth-enhancing small business loans that commercial banks provide, in favor of central bank holdings of sovereign debts and government-favored private securities (for the Fed at present, mortgage-backed securities).[4] The IMF authors of the note observe that in a world where CBDC accounts replace both currency and ordinary checking deposits “only the commercial bank could create money.” Correspondingly, in a world of CBDC alone, only the central bank would direct the loanable funds marshalled by checking deposits.


[1] Bordo and Levin (2017) have suggested that private commercial banks should provide the front end for access to the central bank’s balance sheet, because they are better at customer service. Designated “digital cash” account balances at commercial banks would differ from ordinary account balances only in that balance transfers between accounts would be nearly instantly settled. Near-instant settlement would be enabled by the commercial banks holding “segregated reserve accounts” at the central bank, linked to their customers digital cash accounts, and presumably backed by high or even 100-percent, reserves. Under their proposal commercial banks would act as so many central bank branch agencies. Their proposed system would have all the same drawbacks of outright CBDC accounts discussed herein.

[2] Under the Right to Financial Privacy Act of 1978, a bank or other financial institution is protected from customer lawsuits for disclosing customer account information to a US federal agency (BATF, DEA, FBI, IRS, etc.) that subpoenas it in connection with suspected illegal activity. The agency is required only to notify an individual customer (but not a business customer) of the request, giving the customer ten days to seek legal redress. In court the agency does not need to meet the Fourth Amendment standard of probable cause. Under later statutes including the Patriot Act, notice is not required where the individual is suspected of drug trafficking, espionage, or terrorism. In a recent law review article, W. F. McElroy notes that today “the privacy of financial records from unwarranted government intrusion is under siege.”

[3] Tommaso Mancini-Griffoli, Maria Soledad Martinez Peria, Itai Agur, Anil Ari, John Kiff, Adina Popescu, and Celine Rochon, “Casting Light on Central Bank Digital Currency,” IMF Staff Discussion Note (November 2018).

[4] For theory and evidence on this point see Lastrapes and Selgin (2012).

[Cross-posted from Alt-M.org]

December 3, 2018 3:42PM

Three Basic Principles for Immigration Reform

I have previously described in detail the reforms that America’s immigration system needs. In this post, I want to highlight what I think the general principles behind those reforms should be. Three basic principles should guide immigration reform: openness, equal treatment, and flexibility. Reform should make America more open to immigrants, should treat all immigrants equally as individuals, and should be flexible enough to respond automatically to changes in the economy or society.

1) Openness to new immigrants. Reform should make it easier to immigrate legally, not more difficult. This pillar protects the rights of Americans to associate, contract, and trade with people born in other countries. These people might be their family members, friends, employees, or employers, but ultimately, restrictions on immigration are restriction on the liberty of Americans. Reform should recognize the presumptive right—overcome only for very good reasons—of Americans to freely interact with foreigners on U.S. soil.

Of course, the freedom to associate across borders also benefits Americans—even those who don’t participate directly with the immigration system—by expanding the pool of employees, consumers, investors, and entrepreneurs who produce goods and provide services that improve the quality of life of all Americans. The social capital that immigrants bring with them makes America a stronger, safer country. Immigrants marry, have children, and participate in religious groups at higher rates than the U.S.-born population, and it is precisely for these reasons that they have much lower rates of criminality.

As a practical matter, there are many ways to move toward a more open immigration system. My list of reforms gives specific examples. But here is a general blueprint: grant indefinite work visas to anyone with a job in the United States, confer legal permanent residency on anyone who works for 5 years, and remove the quotas on green cards for immediate family members—adult children and siblings of U.S. citizens as well as spouses and minor children of legal permanent residents.

2) Equal treatment for new immigrants. America has a long legacy of discriminating against certain types of immigrants, from the Chinese Exclusion Act to the Asiatic Bar Zone to the National Origins Quota System. Unfortunately, this legacy is not entirely purged from the statute books. Today, the government still attempts to micromanage the ethnic makeup of legal immigrants by limiting nationals of any particular country to no more than 7 percent of the total green cards. These “per-country caps” discriminate against immigrants from high-demand countries like India, China, and Mexico, while discriminating in favor of those from less populous countries like those in Europe. The caps are not only an affront to the fundamental principles of fairness but they are economically harmful, forcing immigrants with more experience and higher wage offers to wait longer than others.

Last year, President Trump introduced more discrimination into the system by banning all entries from six countries. This effectively imposes a country quota of zero for Iran, Libya, Syria, Somalia, and Yemen. This means that even if an Iranian or Syrian is eligible for a green card under the normal channels, they would still be barred from immigrating. The president previously labeled this an extension of his “Muslim ban” concept. In order to end this discrimination, and prevent it from returning, Congress needs to repeal the per-country limits and bar the president from reimposing similar limitations without explicit authority from Congress.

3) Flexibility to changes in the economy and society. Congress has not updated America’s immigration system in 28 years. During that time, America’s population has grown by a third, and its economy has doubled. Yet the immigration quotas and categories have not changed at all. In order to prevent the immigration system from becoming antiquated, it’s not enough for Congress to merely update it based on what would be best for today—it needs to build a system that is flexible enough to adapt to changes that will happen in the future. Otherwise, the new system will become outdated soon after it is implemented.

Ideally, Congress would end arbitrary quotas on immigration. The government should impose qualitative, not quantitative limits, on immigration. Hard numerical limits are the most rigidity-inducing aspect of the legal immigration system and cause the most harm, but if Congress does maintain quotas, it should go beyond merely updating them. It should link family-based quotas to population growth (or the number of families in the United States) and link employment-based quotas to economic growth, growing as the economy grows.

This would prevent the numbers of immigrants from becoming outdated, but the categories and regulations under which those immigrants enter also fall out of line with the needs of the economy. Consider the fact that there are no programs for lesser-skilled temporary workers who want to work in year-round jobs because Congress in 1990 believed that employers only needed seasonal workers. While Congress can plug the holes as best it can, it should also grant the ability to states to sponsor immigrants based on whatever criteria that the state wants. Canada already has this type of immigration program for its provinces. This would allow states to essentially invent new green card categories, even while the numbers remain largely the same.

With these principles in mind, Congress can construct an immigration system that will provide for America’s economy and society long into the 21st century.

December 3, 2018 10:17AM

Should the Fed Raise Rates Now to Combat Future Recessions?

Many macreconomists believe that the Fed needs to keep raising rates now so it can lower them in future to combat a recession.  See, for example, my colleague Martin Feldstein's recent op-ed in the WSJ.

I have always been puzzled by this argument; it seems to assume an asymmetry in the effects of raising versus lowering rates. 

Specifically, if raising rates now will hurt the economy just as much as lowering them later will help, why is the net effect beneficial? To a first approximation, one might expect a symmetric effect, which makes the standard case for higher rates now unconvincing.