Christopher J Waller: CBDC - A Solution in Search of a Problem?
Speech (via webcast) by Mr Christopher J Waller, Member of the Board of Governors of the
Federal Reserve System, at the American Enterprise Institute, Washington, D.C., 5 August 2021.
* * *
The payment system is changing in profound ways as individuals demand faster payments,
central banks including the Fed respond, and nonbank entities seek a greater role in facilitating
payments. In all this excitement, there are also calls for the Federal Reserve to "get in the game"
and issue a central bank digital currency (CBDC) that the general public could use.
Chair Powell recently announced that the Federal Reserve will publish a discussion paper on the
benefits and costs of creating a CBDC. This topic is of special interest to me, since I have
worked on monetary theory for the last twenty years and researched and written about alternative
1
forms of money for the last seven. My speech today focuses on whether a CBDC would
address any major problems affecting our payment system. There are also potential risks
associated with a CBDC, and I will touch on those at the end of my remarks. But at this early
juncture in the Fed's discussions, I think the first order of business is to ask whether there is
2
compelling need for the Fed to create a digital currency. I am highly skeptical.
In all the recent exuberance about CBDCs, advocates point to many potential benefits of a
Federal Reserve digital currency, but they often fail to ask a simple question: What problem
would a CBDC solve? Alternatively, what market failure or inefficiency demands this specific
intervention? After careful consideration, I am not convinced as of yet that a CBDC would solve
any existing problem that is not being addressed more promptly and efficiently by other initiatives.
Before getting into the details, let me start by clarifying what I mean by "CBDC." Put simply, a
CBDC is a liability of the central bank that can be used as a digital payment instrument. For
purposes of this speech, I will focus on general purpose CBDCs-that is, CBDCs that could be
used by the general public, not just by banks or other specific types of institutions. A general
purpose CBDC could potentially take many forms, some of which could act as anonymous
cash-like payment instruments. For this speech, however, I will focus on account-based forms of
CBDC, which the Bank for International Settlements recently described as "the most promising
3
way of providing central bank money in the digital age." Any such general purpose,
accountbased CBDC would likely require explicit congressional authorization.
Central Bank Money versus Commercial Bank Money
It is useful to note that in our daily lives we use both central bank money and commercial bank
money for transactions. Central bank money (i.e., money that is a liability of the Federal Reserve)
includes physical currency held by the general public and digital account balances held by banks
at the Federal Reserve. The funds banks put into these accounts are called reserve balances,
4
which are used to clear and settle payments between banks. In contrast, checking and savings
accounts at commercial banks are liabilities of the banks, not the Federal Reserve. The bulk of
transactions, by value, that U.S. households and firms make each day use commercial bank
money as the payment instrument.
Federal Reserve Accounts and Commercial Bank Accounts
Under current law, the Federal Reserve offers accounts and payment services to commercial
5
banks. These accounts provide a risk-free settlement asset for trillions of dollars of daily
interbank payments. Importantly, the use of central bank money to settle interbank payments
promotes financial stability because it eliminates credit and liquidity risk in systemically important
6
payment systems.
Congress did not establish the Federal Reserve to provide accounts directly to the general
public; the Federal Reserve instead works in the background by providing accounts to
commercial banks, which then provide bank accounts to the general public. Under this structure,
commercial banks act as an intermediary between the Federal Reserve and the general public.
The funds in commercial bank accounts are digital and can be used to make digital payments to
households and businesses, but commercial banks promise to redeem a dollar in one's bank
account into $1 of U.S. currency. In short, banks peg the exchange rate between commercial
bank money and the U.S. dollar at one-to-one. Due to substantial regulatory and supervisory
oversight and federal deposit insurance, households and firms reasonably view this fixed
exchange rate as perfectly credible. Consequently, they treat commercial bank money and
central bank money as perfect substitutes-they are interchangeable as a means of payment.
The credibility of this fixed exchange rate between commercial and central bank money is what
allows our payment system to be stable and efficient. I will return to this point later.
This division of functions between the Federal Reserve and commercial banks reflects an
economic truth: that markets operate efficiently when private-sector firms compete to provide the
highest-quality products to consumers and businesses at the lowest possible cost. In general,
the government should compete with the private sector only to address market failures.
Consideration of the Case for a Federal Reserve CBDC
This brings us back to my original question: What is the problem with our current payment
system that only a CBDC would solve?
Could it be that physical currency will disappear? As I mentioned before, the key to having
credible commercial bank money is the promise that banks will convert a dollar of digital bank
money into a dollar of U.S. physical currency. But how can banks deliver on their promise if U.S.
currency disappears? Accordingly, many central banks are considering adoption of a CBDC as
their economies become "cashless." Eliminating currency is a policy choice, however, not an
economic outcome, and Chair Powell has made clear that U.S. currency is not going to be
replaced by a CBDC. Thus, a fear of imminently vanishing physical currency cannot be the
7
reason for adopting a CBDC.
Could it be that the payment system is too limited in reach, and that introducing a CBDC would
make the payment system bigger, broader, and more efficient? It certainly doesn't look that way
to me. Our existing interbank payment services have nationwide reach, meaning that an
accountholder at one commercial bank can make a payment to an accountholder at any other
U.S. bank. The same applies to international payments-accountholders at U.S. banks can
transfer funds abroad to accountholders at foreign banks. So, a lack of connectedness and
geographic breadth in the U.S. payment system is not a good reason to introduce a CBDC.
Could it be that existing payment services are too slow? A group of commercial banks has
recently developed an instant payment service (the Real-Time Payment Service, or RTP), and
8
the Federal Reserve is creating its own instant payment service, FedNowSM. These services
will move funds between accountholders at U.S. commercial banks immediately after a payment
is initiated. While cross-border payments are typically less efficient than domestic payments,
9
efforts are underway to improve cross-border payments as well. These innovations are all
moving forward in the absence of a CBDC. Consequently, facilitating speedier payments is not a
compelling reason to create a CBDC.
Could it be that too few people can access the payment system? Some argue that introducing a
CBDC would improve financial inclusion by allowing the unbanked to more readily access
financial services. To address this argument, we need to know, first, the size of the unbanked
population, and second, whether the unbanked population would use a Federal Reserve CBDC
account. According to a recent Federal Deposit Insurance Corporation (FDIC) survey,
approximately 5.4 percent of U.S. households were unbanked in 2019. The FDIC survey also
found that approximately 75 percent of the unbanked population "were not at all interested" or "not
very interested" in having a bank account. If the same percentage of the unbanked population
would not be interested in a Federal Reserve CBDC account, this means that a little more than 1
percent of U.S. households are both unbanked and potentially interested in a Federal Reserve
CBDC account. It is implausible to me that developing a CBDC is the simplest, least costly way
to reach this 1 percent of households. Instead, we could promote financial inclusion more
efficiently by, for example, encouraging widespread use of low-cost commercial bank accounts
11
through the Cities for Financial Empowerment Bank On project.
Could it be that a CBDC is needed because existing payment services are unreasonably
expensive? In order to answer this question, we need to understand why the price charged for a
payment might be considered "high." In economics, the price of a service is typically composed
of two parts: the marginal cost of providing the service and a markup that reflects the market
power of the seller. The marginal cost of processing a payment depends on the nature of the
payment (for example, paper check versus electronic transfer), the technology used (for
example, batched payments versus real-time payments), and the other services provided in
processing the payment (for example, risk and fraud services). Since these factors are primarily
technological, and there is no reason to think that the Federal Reserve can develop cheaper
technology than private firms, it seems unlikely that the Federal Reserve would be able to
process CBDC payments at a materially lower marginal cost than existing private-sector
12
payment services.
The key question, then, is how a CBDC would affect the markup charged by banks for a variety
of payment services. The markup that a firm can charge depends on its market power and thus
the degree of competition it faces. Introducing a CBDC would create additional competition in the
market for payment services, because the general public could use CBDC accounts to make
payments directly through the Federal Reserve-that is, a CBDC would allow the general public
to bypass the commercial banking system. Deposits would flow from commercial banks into
CBDC accounts, which would put pressure on banks to lower their fees, or raise the interest rate
13
paid on deposits, to prevent additional deposit outflows.
It seems to me, however, that private-sector innovations might reduce the markup charged by
14
banks more effectively than a CBDC would. If commercial banks are earning rents from their
market power, then there is a profit opportunity for nonbanks to enter the payment business and
provide the general public with cheaper payment services. And, indeed, we are currently seeing a
surge of nonbanks getting into payments. For example, in recent years, "stablecoin"
arrangements have emerged as a particularly important type of nonbank entrant into the
payments landscape. Stablecoins are digital assets whose value is tied to one or more other
assets, such as a sovereign currency. A stablecoin could serve as an attractive payment
instrument if it is pegged one-to-one to the dollar and is backed by a safe and liquid pool of
15
assets. If one or more stablecoin arrangements can develop a significant user base, they
could become a major challenger to banks for processing payments. Importantly, payments
using such stablecoins might be "free" in the sense that there would be no fee required to initiate
16
or receive a payment. Accordingly, one can easily imagine that competition from stablecoins
could pressure banks to reduce their markup for payment services.
Please note that I am not endorsing any particular stablecoin-some of which are not backed by
safe and liquid assets. The promise of redemption of a stablecoin into one U.S. dollar is not
perfectly credible, nor have they been tested by an actual run on the stablecoin. There are many
legal, regulatory, and policy issues that need to be resolved before stablecoins can safely
17
proliferate. My point, however, is that the private sector is already developing payment
alternatives to compete with the banking system. Hence, it seems unnecessary for the Federal
Reserve to create a CBDC to drive down payment rents.
Returning to possible problems a CBDC could solve, it is often argued that the creation of a
CBDC would spur innovation in the payment system. This leads me to ask: do we think there is
insufficient innovation going on in payments? To the contrary, it seems to me that private-sector
innovation is occurring quite rapidly-in fact, faster than regulators can process. So, spurring
innovation is not a compelling reason to introduce a CBDC.
Could it be, however, that the types of innovations being pursued by the private sector are the
"wrong" types of payment innovations? I see some merit in this argument when I consider
cryptoassets such as bitcoin that are often used to facilitate illicit activity. But a CBDC is unlikely to
deter the use of crypto-assets that are designed to evade governmental oversight.
Could the problem be that government authorities have insufficient information regarding the
financial transactions of U.S. citizens? In general, the government has sought to balance
individuals' right to privacy with the need to prevent illicit financial transactions, such as money
laundering. For example, while the government does not receive all transaction data regarding
accountholders at commercial banks, the Bank Secrecy Act requires that commercial banks
report suspicious activity to the government.
Depending on its design, CBDC accounts could give the Federal Reserve access to a vast
amount of information regarding the financial transactions and trading patterns of CBDC
accountholders. The introduction of a CBDC in China, for example, likely will allow the Chinese
government to more closely monitor the economic activity of its citizens. Should the Federal
Reserve create a CBDC for the same reason? I, for one, do not think so.
Could the problem be that the reserve currency status of the U.S. dollar is at risk and the creation
of a Federal Reserve CBDC is needed to maintain the primacy of the U.S. dollar? Some
commentators have expressed concern, for example, that the availability of a Chinese CBDC will
undermine the status of the U.S. dollar. I see no reason to expect that the world will flock to a
Chinese CBDC or any other. Why would non-Chinese firms suddenly desire to have all their
financial transactions monitored by the Chinese government? Why would this induce
nonChinese firms to denominate their contracts and trading activities in the Chinese currency
instead of the U.S. dollar? Additionally, I fail to see how allowing U.S. households to, for example,
pay their electric bills via a Federal Reserve CBDC account instead of a commercial bank
account would help to maintain global dollar supremacy. (Of course, Federal Reserve CBDC
accounts that are available to persons outside the United States might promote use of the dollar,
but global availability of Federal Reserve CBDC accounts would also raise acute problems
related to, among other things, money laundering.)
Finally, could it be that new forms of private money, such as stablecoins, represent a threat to
the Federal Reserve for conducting monetary policy? Many commentators have suggested that
new private monies will diminish the impact of the Federal Reserve's policy actions, since they
will act as competing monetary systems. It is well established in international economics that any
country that pegs its exchange rate to the U.S. dollar surrenders its domestic monetary policy to
the United States and imports U.S. monetary policy. This same logic applies to any entity that
pegs its exchange rate to the U.S. dollar. Consequently, commercial banks and stablecoins
pegged to the U.S. dollar act as conduits for U.S. monetary policy and amplify policy actions. So,
if anything, private stablecoins pegged to the dollar broaden the reach of U.S. monetary policy
rather than diminish it.
After exploring many possible problems that a CBDC could solve, I am left with the conclusion
that a CBDC remains a solution in search of a problem. That leaves us only with more
philosophical reasons to adopt a CBDC. One could argue, for example, that the general public
has a fundamental right to hold a riskless digital payment instrument, and a CBDC would do this
18
in a way no privately issued payment instrument can. On the other hand, thanks to federal
deposit insurance, commercial bank accounts already offer the general public a riskless digital
payment instrument for the vast majority of transactions.
One could also argue that the Federal Reserve should provide a digital option as an alternative to
the commercial banking system. The argument is that the government should not force its
citizens to use the commercial banking system, but should instead allow access to the central
19
bank as a public service available to all. As I noted earlier in my speech, however, the current
congressionally mandated division of functions between the Federal Reserve and commercial
banks reflects an understanding that, in general, the government should compete with the private
sector only to address market failures. This bedrock principle has stood America in good stead
since its founding, and I don't think that CBDCs are the case for making an exception.
In summary, while CBDCs continue to generate enormous interest in the United States and other
countries, I remain skeptical that a Federal Reserve CBDC would solve any major problem
confronting the U.S. payment system. There are also potential costs and risks associated with a
CBDC, some of which I have alluded to already. I have noted my belief that government
interventions into the economy should come only to address significant market failures. The
competition of a Fed CBDC could disintermediate commercial banks and threaten a division of
labor in the financial system that works well. And, as cybersecurity concerns mount, a CBDC
could become a new target for those threats. I expect these and other potential risks from a
CBDC will be addressed in the forthcoming discussion paper, and I intend to expand upon them
as the debate over digital currencies moves forward.
1
For example, in 2016, my coauthors and I published a research paper that examined how the use of a privately
issued currency backed up by shares of a broad stock market index could replace publicly issued fiat currency.
See David Andolfatto, Aleksander Berentsen and Christopher Waller, "Monetary Policy with Asset-Backed
Money," Journal of Economic Theory 164 (July 2016): 166-86. Return to text
2
These views are my own and do not represent any position of the Board of Governors or other Federal Reserve
policymakers. Return to text
3
See Bank for International Settlements, Annual Economic Report (Basel: Bank for International Settlements,
June 2021). Note that any CBDC would require some kind of supporting technology. For example, many
commentators have considered the possibility that a CBDC could operate using a "distributed ledger."
Additionally, an account-based CBDC could potentially take different forms. For example, the infrastructure for an
account-based CBDC could be designed so that the Federal Reserve would interact directly with the general
public, or it could be designed so that banks or other service providers would maintain all customer
relationships with the general public. My comments today focus on the policy issues associated with providing a
CBDC rather than on technologies or infrastructure that would be necessary to support a CBDC. Return to text
4
The Federal Reserve also provides accounts and payment services to the United States government, certain
government-sponsored enterprises, designated financial market utilities, foreign central banks, and certain
international organizations. Return to text
5
For this purpose, I use the term "commercial bank" broadly to include banks, thrifts, credit unions, and other
depository institutions. Return to text
6
See, for example, Committee on Payment and Settlement Systems, The Role of Central Bank Money in
Payment Systems (PDF) (Basel: Bank for International Settlements, August 2003). Return to text
7
Physical currency can effectively disappear, and everything still works. All the central bank needs to do is
promise to provide the currency if requested. Return to text
8
These services will complement the existing automated clearinghouse (ACH) payment network, which now
enables same-day settlement of ACH payments. Return to text
9
Financial Stability Board, "FSB Delivers a Roadmap to Enhance Cross-Border Payments," news release,
October 13, 2020. Return to text
10
"Key Findings from How America Banks: Household Use of Banking and Financial Services," Federal Deposit
Insurance Corporation. Return to text
See joinbankon.org/. Return to text
12
Note that section 11A of the Federal Reserve Act (12 U.S.C. § 248a) directs the Federal Reserve to establish a
fee schedule for its payment services. Over the long run, these fees are set "on the basis of all direct and
indirect costs actually incurred in providing , including interest on items credited prior to actual collection,
overhead, and an allocation of imputed costs which takes into account the taxes that would have been paid and
the return on capital that would have been provided had the services been furnished by a private business firm...
." Return to text
13
See David Andolfatto "Assessing the Impact of Central Bank Digital Currency on Private Banks," The Economic
Journal 131 (February 2021): 525-40. Return to text
14
The Federal Reserve's longstanding policy is to offer new payment services to its accountholders only when
"other providers alone cannot be expected to provide with reasonable effectiveness, scope, and equity." See
"The Federal Reserve in the Payments System" (issued 1984; revised 1990 and 2001). Return to text
15
A well-designed stablecoin would function similarly to a "narrow bank," which has a long tradition in economic
theory but has never existed in any serious way as a competitor for commercial banks. Narrow banks take
deposits and issue liabilities on themselves much like a standard bank. However, narrow banks hold only
liquid, very safe assets that back up their liabilities 100 percent. They do not make loans or hold risky
securities. Return to text
16
However, stablecoin payment might not be free in the sense that stablecoin users would allow their financial
transaction data to be harvested and monetized. Return to text
17
The President's Working Group on Financial Markets expects to issue recommendations related to stablecoins
in the coming months. See home.treasury.gov/news/press-releases/jy0281. Return to text
18
See Aleksander Berentsen and Fabian Schar "The Case for Central Bank Electronic Money and the Non-Case
for Central Bank Cryptocurrencies," Federal Reserve Bank of St. Louis, Review 100, no. 2 (Second Quarter
2018). Return to text
19
See David Andolfatto "Fedcoin: On the Desirability of a Central Bank Cryptocurrency," Macromania Blog,
February 3, 2015, andolfatto.blogspot.com/2015/02/fedcoin-on-desirability-of-government.html. Return to text