Central bank digital coin would be more useful than cash, but cash likely to remain

Cash may no longer be king, but it's probably never going to leave the kingdom.

This was, effectively, the conclusion of a paper from the National Bureau of Economic Research, which develops and analyzes a model highlighting the tradeoffs between physical cash and a Central Bank Digital Coin.

A CBDC is basically a government-backed virtual currency, which stands in contrast with cryptocurrencies that were specifically built to not need backing from a sovereign power. Other nations are already experimenting internally with such a thing, including China, while others, such as the U.S., are considering doing the same. The Treasury Department, in a report last year, recommended that the U.S. begin developing its own digital currency, just in case it ever wants to use one.

The NBER paper says a CBDC is much more efficient and flexible than cash and carries far fewer risks.

"Cash has a higher transaction cost than CBDC, a zero nominal rate of return, and allows for tax evasion. CBDC has a lower transaction cost than cash, could pay interest (which can be positive or negative), and transactions using it are subject to taxation. The agent pays a penalty on tax evasion with a constant probability of being monitored," said the paper, adding that the CBDC also allows for more monetary policy interventions via things like "helicopter drops," government-backed stimulus measures that infuse money widely into the economy.

There is a chance that the introduction of a CBDC into an economy might cause cause capital flight away from banks, thus causing financial instability, but the paper said there are ways they can be designed to mitigate this possibility.

The study raises the question of why countries don't do away with physical cash altogether. Part of the answer is that doing so would have deep political implications, and policy makers likely would not want to grapple with them.

"Even proponents of CBDC note that there are privacy concerns and other political considerations that make it infeasible or, at a minimum, unwise for a government to do away with cash altogether. For instance, in a recent report the [Bank of International Settlements] lays out a 'foundational principle' that a CBDC would need to co-exist with and complement existing forms of money," said the paper.

It also noted that lower-income people tend to rely on cash more and have less access to electronic banking systems. Thus, eliminating cash may disproportionately impact the poor. The paper recommended governments encourage people to abandon cash versus forcing them to do so. It also noted that one of the goals of a CBDC is to increase financial inclusion by giving households easy and low-cost access to an electronic form of payment.