As we witness daily how digitalization is changing the way people pay, central bankers have been exploring the merits of moving away from cash and into digital currencies (the term used is CBDC). The most recent addition to this research is the report of the Bank of International Settlements. The COVID-19 pandemic has accelerated the likelihood of CBDC as more businesses shun the use of cash in daily transactions for both health/safety reasons as well as overall efficiency. Consequently, investors have poured funds into a variety of fintech companies (e.g. Square, PayPal, Visa, MC) who have developed the technical capability to challenge the commercial banks' payment systems. Broadly speaking, the fintech companies aim to speed up settlements, reduce end-user costs, facilitate peer-to-peer money transactions, and to expand their user base to gain maximum operational scale. (The reader should not confuse Bitcoin and other stable coins which operate outside the banking system).

It used to be a fantasy that government would make payments directly to individuals, the so-called ‘helicopter’ money.  No longer is the case. Governments have sought to make direct deposits of cash into individual bank accounts as part of their overall efforts to deal with the dire consequences of the pandemic. The central banks did not have a digital currency policy in place, so bureaucrats had to use the more cumbersome methods of cash deposits through the commercial banking system. The pandemic highlighted the need to get funds rapidly into the hands of households as the lockdowns shuttered businesses.

Critics of CBDC argue that it will foster disintermediation of the banking system--- that is, the banks will be by-passed and experience a drop in deposits. However, research at the Bank of Canada concluded that Canadian commercial banks are well-capitalized and have adequate liquidity to deal with a temporary negative impact on their ability to attract deposits (The potential effect of a central bank digital currency on deposit funding in Canada).

Other critics argue that CBDC will unleash inflation as central banks will have free reign to put money directly in the hands of households. But central banks have long been pumping cash into the economy through normal credit creation and through extraordinary measures such as quantitative easing. Neither have been able to counter the deflationary trends that exist today.