Choice In Currency

LARGE PRINT EDITION! More at LargePrintLiberty.com. The pathbreaking book first appeared in 1976, during an inflationary bout in the United States. Hayek argued that it is crucial to the health of the market as a whole to bring the forces of competition to bear in currency markets, not just between countries but within them as well. All people should be free to use any currency of their own choosing, Hayek contended, even if that means rejecting the favored domestic one. This provides a check against inflation, permitting citizens to keep assets denominated in any unit. Governments will thus have greater incentive to avoid inflating because a depreciating unit will lead people to flee to other currencies. At least this would work as some check, and it would be a great improvement over the existing system in which citizens in a currency region are caged sheep led to the slaughter. This book is an important work in part because it represents a reform that could take place right now, one that would change the institutional incentives faced by central banks. This is not Hayek's full plan for sound money but rather a creative idea to diminish the total power of central banks within individual countries. It was a good idea in 1976, and it's still a good idea in the 21st century.

Would the introduction of a Central Bank Digital Currency (CBDC) lead to lower deposits (disintermediation) and lending in the banking sector? This paper develops a model where households heterogeneous in wealth allocate between an illiquid asset and assets that can be used for payments: bank deposits, cash, and CBDC. CBDC is more efficient as a means of payment and has lower access cost than deposits. Deposits are offered by an imperfectly competitive banking sector which raises deposit interest rates after CBDC introduction to prevent substitution away from deposits to CBDC. We find that there are two opposing margins of impact on the level of aggregate deposits: (1) the intensive margin gain in deposits by richer households increasing their holdings of deposits because of higher interest rates, and (2) the extensive margin loss of deposits among poorer households who switch from deposits to the CBDC. The extensive margin loss in deposits is more likely to dominate (yielding a fall in aggregate deposits) when the mass of poorer households is large and when it is relatively costly to access bank accounts. This tends to be the case in developing and emerging market economies. However, even when the extensive margin loss of deposits dominates and there is disintermediation, the impact on lending is quantitatively small if banks have access to other forms of funding, such as wholesale or central bank financing.