CBDC: A Solution in Search of a Problem?
By Governor Christopher J. Waller at the American Enterprise Institute, Washington, D.C. (via webcast) |
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 forms of money for the last seven.1 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 compelling need for the Fed to create a digital currency. I am highly skeptical.2
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 way of providing central bank money in the digital age.”3 Any such general purpose, account-based 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, which are used to clear and settle payments between banks.4 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 banks.5 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 payment systems.6
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 reason for adopting a CBDC.7
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 the Federal Reserve is creating its own instant payment service, FedNowSM.8 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, efforts are underway to improve cross-border payments as well.9 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 2019.10 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 through the Cities for Financial Empowerment Bank On project.11
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 payment services.12
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 paid on deposits, to prevent additional deposit outflows.13
It seems to me, however, that private-sector innovations might reduce the markup charged by banks more effectively than a CBDC would.14 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 assets.15 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 or receive a payment.16 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 proliferate.17 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 crypto-assets 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 non-Chinese 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 in a way no privately issued payment instrument can.18 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 bank as a public service available to all.19 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.
Compliments of the U.S. Federal Reserve.
The post U.S. FED | Speech by Governor Waller on central bank digital currency first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

The OECD has published updated transfer pricing country profiles, reflecting the current transfer pricing legislation and practices of 20 jurisdictions. These updated profiles also contain new information on countries’ legislation and practices regarding the transfer pricing treatment of financial transactions and the application of the Authorised OECD Approach (AOA) to attribute profits to permanent establishments.
The transfer pricing country profiles focus on countries’ domestic legislation regarding key transfer pricing aspects, including the arm’s length principle, methods, comparability analysis, intangible property, intra-group services, cost contribution agreements, documentation, administrative approaches to avoiding and resolving disputes, safe harbours and other implementation measures. In addition, the newly updated country profiles include two new sections. The first section relates to the transfer pricing treatment of financial transactions and the second on the application of the AOA to Permanent Establishments. The information contained in the country profiles is intended to clearly reflect the current state of countries’ legislation and to indicate to what extent their rules follow the OECD Transfer Pricing Guidelines and the AOA to Permanent Establishments. The information was provided by countries themselves in response to a questionnaire so as to achieve the highest degree of accuracy.
The OECD has published transfer pricing country profiles since 2009, providing high-level information about the transfer pricing systems for OECD members and associate jurisdictions. In 2017, the country profiles were significantly modified to reflect the changes in the transfer pricing framework of jurisdictions as a result of the 2015 OECD/G20 Base Erosion and Profit Shifting (BEPS) Project reports on Actions 8-10 and on Action 13 which introduced revisions to the OECD Transfer Pricing Guidelines. The country profiles were also expanded to cover non-OECD member jurisdictions.
Updates to the transfer pricing country profiles will be conducted in batches throughout the second half of 2021 and the first half of 2022. With this first batch, the profiles for 20 jurisdictions have been updated, including three new country profiles from Inclusive Framework members (Angola, Romania and Tunisia) bringing the total number of countries covered to 60.
Compliments of the OECD.
The post OECD updates transfer pricing country profiles to include new fields on financial transactions and permanent establishments first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

The EU bank funds will help to increase the competitiveness of the Spanish company by boosting its investments from 2021 to 2024, focusing on digitalisation and the improvement of facilities.
The EIB-financed project will enable Fagor Arrasate to develop machinery for the production of lighter, more environmentally friendly vehicles, as well as components for electric vehicles.
The agreement is supported by the European Fund for Strategic Investments (EFSI).

The European Investment Bank (EIB) and Fagor Arrasate (a cooperative and part of the Mondragón Group) today signed a new agreement to finance the Basque company’s research, development and innovation (RDI). To this end, the EIB will provide €10 million to Fagor Arrasate to finance nine strategic RDI projects for a total investment of €24 million to be developed by the Gipuzkoa-based cooperative between 2021 and 2024. The project is backed by a guarantee from the European Fund for Strategic Investments (EFSI), the main pillar of the Investment Plan for Europe.
The EIB support will enable Fagor Arrasate to strengthen its competitiveness by making strategic investments in key internal processes in the production of heavy machinery, as well as in the development of advanced machinery and digital services to meet the future challenges of European industry’s strategic sectors. The agreement will contribute to improving technologies for processing new lightweight materials mainly for the automotive sector, in addition to improvements to existing production facilities.
The project is expected to have a positive environmental impact as a major part of the innovation centres on the development of machinery that will enable car manufacturers to make lighter, more environmentally friendly vehicles, as well as to produce components for electric vehicles. The EIB is firmly committed to continuing to support innovation in the automotive sector in Spain, having financed and worked with several companies in the sector during the pandemic.
This will be the first operation with Fagor Arrasate, although the EIB has already worked with several Mondragón Group cooperatives.
Paolo Gentiloni, European Commissioner for the Economy, added: “With help from the Investment Plan for Europe and the EIB, Spanish company Fagor Arrasate will invest in new manufacturing technologies and the development of machinery for producing electric vehicles. This is good news for competitiveness and for the green transition in the Spanish automotive sector.”
EIB Vice-President Ricardo Mourinho Félix said: “We are very proud to finance Fagor Arrasate’s RDI strategy, promoting the digitalisation and advanced production techniques of this Spanish company through greater sustainability that will undoubtedly enable it to strengthen its competitiveness. This operation demonstrates the EIB’s strong commitment to an economic recovery based on innovation and environmental protection, as well as to supporting the automotive industry, which is key to the Spanish economy and job creation — the EIB’s priority objectives in Spain.”
President of the Fagor Arrasate Governing Board Iñaki Martínez stressed that this EU bank’s decision “shows the EIB’s firm support for Fagor Arrasate’s strategy, providing the funds needed to undertake future projects that will enable us to improve our competitiveness and be a leading benchmark for our customers.”
The project also fosters technological leadership and competitiveness in European industry and directly and indirectly supports economic growth and employment in Europe.
Background information:
The European Investment Bank (ElB) is the long-term lending institution of the European Union owned by its Member States. It makes long-term finance available for sound investment in order to contribute towards EU policy objectives.
The European Fund for Strategic Investments (EFSI) is the main pillar of the Investment Plan for Europe. It provides first loss guarantees, enabling the EIB to invest in more projects that often come with increased risk. The projects and agreements approved for financing under EFSI have so far mobilised €546.5 billion in investment, a quarter of which is going to research, development and innovation projects.
About Fagor Arrasate:
Fagor Arrasate is a world leader in the design and manufacture of material forming equipment for the production of complex parts in metal, composites and thermoplastics. With six plants across the world, Fagor Arrasate distributes its products to more than 70 countries and has installations with leading car manufacturers, Tier suppliers, steel and aluminium coil and sheet processors, and producers of forged parts and electrical steel, as well as manufacturers of appliances and metal furniture.
Compliments of the European Commission.
The post EIB supports Fagor Arrasate’s innovation and digitalisation strategy first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Today, the European Commission has approved its seventh Advanced Purchase Agreement (APA) with a pharmaceutical company to ensure access to a potential vaccine against COVID-19 in Q4 of 2021 and in 2022.
Under this contract, Member States will be able to purchase up to 100 million doses of the Novavax vaccine, with an option for 100 million additional doses over the course of 2021, 2022, and 2023, once reviewed and approved by EMA as safe and effective. Member States will also be able to donate vaccines to lower and middle-income countries or to re-direct them to other European countries.
Today’s contract complements  an already broad portfolio of vaccines to be produced in Europe, including the contracts with AstraZeneca, Sanofi-GSK, Janssen Pharmaceutica NV, BioNtech-Pfizer, CureVac, Moderna and the concluded exploratory talks with Valneva. It represents another key step towards ensuring that Europe is well prepared to face the COVID-19 pandemic.
The President of the European Commission, Ursula von der Leyen, said: “As new coronavirus variants are spreading in Europe and around the world, this new contract with a company that is already testing its vaccine successfully against these variants is an additional safeguard for the protection of our population. It further strengthens our broad vaccine portfolio, to the benefit of Europeans and our partners worldwide.”
Stella Kyriakides, Commissioner for Health and Food Safety, said: “Vaccinations in the EU are advancing and we are closer to our target of 70% fully vaccinated citizens by the end of summer. Our new agreement with Novavax expands our vaccine portfolio to include one more protein-based vaccine, a platform showing promise in clinical trials. We will continue working tirelessly to ensure that our vaccines continue to reach citizens in Europe and around the world, to end the pandemic as quickly as possible.”
Novavax is a biotechnology company developing next-generation vaccines for serious infectious diseases. Their COVID-19 vaccine is already under rolling review by EMA in view of a potential market authorisation.
The Commission has taken a decision to support this vaccine based on a sound scientific assessment, the technology used, the company’s experience in vaccine development and its production capacity to supply the whole of the EU.
Background
The European Commission presented on 17 June a European strategy to accelerate the development, manufacturing and deployment of effective and safe vaccines against COVID-19. In return for the right to buy a specified number of vaccine doses in a given timeframe, the Commission finances part of the upfront costs faced by vaccines producers in the form of Advance Purchase Agreements.
In view of the current and new escape SARS-CoV-2 variants, the Commission and the Member States are negotiating with companies already in the EU vaccine portfolio new agreements that would allow to purchase rapidly adapted vaccines in sufficient quantities to reinforce and prolong immunity.
In order to purchase the new vaccines, Member States are allowed to use the REACT-EU package, one of the largest programmes under the new instrument Next Generation EU that continues and extends the crisis response and crisis repair measures.
Compliments of the European Commission.
The post Coronavirus: EU Commission approves new contract for a potential COVID-19 vaccine with Novavax first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Have you or one of your employees received an alarming text message about unemployment insurance benefits from what seems to be your state workforce agency? You’re not alone. Identity thieves are targeting millions of people nationwide with scam phishing texts aimed at stealing personal information, unemployment benefits, or both.
The phishing texts try to dupe the recipient to click a link to “make necessary corrections” to their unemployment insurance (UI) claim, “verify” their personal information, or “reactivate” their UI benefits account. The link takes you to a fake state workforce agency website that may look very real. There, you’re asked to input your website credentials and personal information, like your Social Security number. Fraudsters can use the information to file fraudulent UI benefits claims or for other identity theft.
Here are examples of some of the phishing texts.

Protect yourself and your employees. Let your staff know that state agencies don’t send text messages asking for personal information. If you get an unsolicited text or email that looks like it’s from a state workforce agency, don’t reply or click any link. If you’re not sure, contact the workforce agency directly using the State Directory for Reporting Unemployment Identity Theft at the bottom of this United States Department of Labor webpage.
Author:

Seena Gressin

Compliments of the U.S. Federal Trade Commission.
The post Businesses: Phishing scheme targets unemployment benefits, PII first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

The implications of savings accumulated during the pandemic for the global economic outlook

The coronavirus (COVID-19) pandemic has led to the accumulation of a large stock of household savings across advanced economies, significantly above what has historically been observed. Owing to their large size, the savings accumulated since early 2020 have the potential to shape the post-pandemic recovery. The central question is whether households will spend heavily once pandemic-related restrictions are lifted and consumer confidence returns, or whether other motives (e.g. precautionary, deleveraging) will keep households from spending their accumulated excess savings. In this box we consider a set of non-euro area economies and conclude that, on the balance of economic arguments, any reduction in the stock of excess savings as a result of higher consumption is likely to be limited in the medium term. However, given the considerable uncertainty surrounding this central scenario, this box also looks at two alternative savings scenarios and assesses their implications for the global economic outlook using the Oxford Global Economic Model.
The accumulation of large savings stems from the distinctive features of the COVID-19 pandemic and the policy responses. In contrast to previous economic recessions, the containment measures adopted in response to COVID-19 saw a significant suppression of consumer spending opportunities, leading to a sizeable contraction in private consumption. This was partially offset by the extraordinary policy measures deployed by governments in the form of either income or employment support, which cushioned the negative impact on personal disposable income (Chart A, panel a). These two factors, together with the high uncertainty regarding future income and the risks of permanent scarring effects, led households to save at unprecedented rates during 2020, resulting in the accumulation of a large stock of excess savings.
In 2020, the stock of household savings accumulated across five large advanced economies[1] in excess of historical values amounted to an average of 6.7 % of GDP and 9.5% of disposable income (Chart A, panel b). Of these countries, the United States held the largest stock at the end of 2020 (USD 1.5 trillion, or 7.2% of US GDP), but other countries also held sizeable amounts of excess savings. The stock of excess savings accumulated between early 2020 and the end of the year is estimated by calculating the cumulative difference between real savings and a counterfactual scenario where the saving ratio is assumed to have remained equal to the pre-pandemic average throughout the year. Similarly, our central scenario assumes that, up to the end of 2023, the stock of excess savings remains close to the level observed prior to the start of 2021, while the saving ratio is assumed to converge back to the pre-pandemic average.

Chart A
Private final consumption expenditure and excess household savings
a) Private final consumption expenditure breakdown
(annual percentage change, percentage points)

b) Excess household savings in the fourth quarter of 2020
(percentages)
Sources: National sources and ECB calculations.
Notes: The advanced economies (AE) aggregate is calculated as the weighted average of excess savings across the five countries shown in the chart. “US” refers to the United States, “UK” to the United Kingdom, “JP” to Japan, “CA” to Canada and “AU” to Australia.

Several arguments support the central scenario that households will prefer to hold most of their accumulated excess savings rather than using them to purchase consumption goods. We review these arguments briefly below, before illustrating the macroeconomic implications of two alternative savings scenarios.
First, the savings accumulated during the pandemic have mostly accrued to high-income households, who have a lower marginal propensity to spend out of income or wealth compared with low-income households.[2] In the United Kingdom, for instance, survey-based data show that high-income households increased their savings during the pandemic, while lower and middle-income households saved less or even dissaved. Similarly, in the United States there is evidence that the distribution of excess savings across income groups is heavily skewed in favour of high-income households and that these savings are held mostly in liquid form, i.e. currency and deposits (Chart B, both panels). A similar situation holds in the euro area, where the accumulation of savings during the pandemic has been concentrated among older and higher-income households (for details, see Box 4 in this issue of the Economic Bulletin). In Japan, available data likewise suggest that savings have accumulated mainly among middle and high-income households. In general, high-income households are likely to have saved more during the pandemic, as they experienced lower income losses than low-income households and tend to allocate a higher share of their consumption basket to the services that were most constrained during the lockdowns. For example, available data indicate that, before the pandemic, UK households in the top income decile devoted close to 40% of their expenditures to services such as transportation, recreation, hotels and restaurants.[3]

Chart B
Financial assets and liabilities of households
a) US checkable deposits and currency across income quintiles
(USD trillions; percentiles)

b) Financial assets and liabilities of households
(USD billions; GBP billions; JPY trillions)
Sources: US Federal Reserve System (panel a); national sources and ECB calculations (panel b).

Second, households may use part of their accumulated savings to repay debt or to invest in assets. With regard to financial accounts, the accumulation of large savings has been associated with a surge in household bank deposits during the lockdowns. Prior to the end of 2020 only a small proportion of these savings had been used to repay debt or purchase assets such as equities (Chart B, panel b). This liquidity preference could partly reflect high uncertainty among households, in addition to reduced availability of consumption opportunities amid persisting COVID-19-related restrictions. As uncertainty recedes, a larger proportion of savings could be channelled towards investments or debt repayment. In the United States, the Federal Reserve Bank of New York’s Survey of Consumer Expectations suggested that most of the funds received by households in the form of stimulus cheques would go towards savings (41%) and debt payments (34%), while only about 25% would be used for consumption.[4] In the United Kingdom, the 2020 H2 NMG Survey suggested that only 10% of households whose savings rose planned to spend them, while 70% favoured continuing to hold their savings in bank accounts.[5] The remainder planned to use their savings to pay off debts, invest or top up their retirement plans.
Third, Ricardian equivalence effects may weigh on households’ propensity to consume, all else being equal.[6] The considerable income support provided to households and other policy measures taken during the pandemic led to a strong dissaving in the public sector and an associated increase in public debt. In the future, Ricardian equivalence effects may arise, to the extent that households expect tax rises aimed at reducing the public debt accrued during the COVID-19 shock and are thus less inclined to consume their accumulated excess savings. In this regard, it is worth noting that both the US Government and the UK Government have announced personal income tax increases, which are expected to weigh on households’ propensity to consume.
Fourth, the scope for sizable pent-up demand appears limited. While the easing of mobility restrictions and the progressive reopening of contact-intensive sectors will relieve household demand for consumption of related services (e.g. travel, restaurants and cultural activities), the latter are less prone than consumption goods to massive bouts of pent-up demand.[7] In particular, while consumers might have an incentive to switch to more expensive services (e.g. holidays and restaurants), there is a limit on the extent to which they can catch up in terms of missed consumption. In addition, as the pandemic-related containment measures severely limited consumption opportunities in the services sector, part of household spending switched towards consumption of goods. Data on real personal consumption expenditures of US households show that spending on durable and non-durable goods bounced back quickly after falling considerably in April 2020; by the end of the second quarter of 2020, overall spending had returned to the levels observed at the end of 2019 and has subsequently continued to grow. Expenditures on services, while recovering at a slower pace, stood at around 5% below pre-pandemic levels by March 2021.
Nonetheless, uncertainty around the relative strength of the factors that could influence how much of the accumulated savings is spent remains high. On the one hand, a gradual but lasting re-opening of economies, as the pandemic is brought under control, would lead households to de-accumulate savings at a faster pace than assumed in our central scenario, reflecting the fact that these savings were forced to a certain extent as the response to the pandemic curtailed consumption opportunities. Being held mostly in liquid assets, savings could be spent very easily. The resumption of contact-intensive activities such as shopping and dining will restore spending opportunities that were previously unavailable, in particular for high-income households that devote a larger share of their consumption basket to such activities. Moreover, as the recovery progresses and employment prospects improve, precautionary motives for saving, which played an important role in 2020, may also become less relevant as households regain confidence about their economic and health prospects (Chart C). On the other hand, setbacks in bringing the virus under control, prolonged restrictions, new lockdown measures and weaker labour market prospects could lead households to further accumulate savings, compared with the central scenario, and thus delay the recovery.

Chart C
Breakdown of household savings by motive
(percentages of disposable income and percentage points contribution)
Sources: National sources and ECB calculations.
Notes: The analysis covers the period from the first quarter of 1995 to the fourth quarter of 2020. The ratio of household savings to disposable income in 2020 (red dots) is modelled in an ordinary least squares (OLS) framework and is expressed as a function of its own lag, the unemployment rate, economic confidence and country-specific lockdown measures, as captured by the Goldman Sachs Effective Lockdown Index.

Chart D
Scenario projections for the household saving ratio and stock of excess household savings
(percentages of disposable income (left panel); percentages of GDP (right panel))
Sources: ECB calculations based on the Oxford Global Economic Model.
Note: Results are aggregated using weighted GDP.

To assess the macroeconomic implications of alternative savings scenarios for the United States, the United Kingdom and Japan, we consider two alternative scenarios[8] for the stock of excess savings. These are (i) a “cut-back” scenario, which assumes that the stock of excess savings accumulated by the second quarter of 2021 will decrease by 70% over the next two and a half years, and (ii) a “build-up” scenario, which assumes that the saving ratio will return to pre-pandemic levels only in the fourth quarter of 2023, implying that households will increase their current excess savings by a further 30%. As a result, average excess savings in these economies would decline to 2.7% of GDP in the cut-back scenario and increase to 12.6% of GDP in the build-up scenario by the end of 2023 (Chart D). We use the Oxford Global Economic Model to quantify the effects of the two scenarios on the global macroeconomic outlook.[9]

Chart E
Macroeconomic impact of alternative household savings scenarios on GDP and CPI in the “cut-back” and “build-up” scenarios
(percentage deviation from central scenario level)
Sources: ECB calculations based on the Oxford Global Economic Model.
Notes: The impact on GDP and CPI in key advanced economies (AEs) is the GDP-weighted average impact across the United States, the United Kingdom and Japan; spillovers are assessed using the Oxford Global Economic Model, where “world” refers to the global economy, including the United States, the United Kingdom and Japan.

In the cut-back scenario, the faster reduction of savings in the form of higher private consumption supports aggregate demand and a pick-up of inflation. In key advanced economies, real GDP is projected to peak at 2.6% above the central scenario level in 2022 (Chart E). This positive boost would be partly counteracted in 2023 by stronger imports becoming a drag on GDP. The increase in aggregate demand would also support price pressures, which would gradually increase over the projection horizon and translate into higher inflation rates (1% above the central scenario level in 2023). The global impact would be significant, with world real GDP standing at 0.6% above the central scenario level in 2021, 1.3% above in 2022 and around 1% above in 2023. Global inflation would also increase, with consumer prices rising to around 0.9% above the central scenario level in 2023, supported by global demand conditions.
In the build-up scenario, households continue to accumulate savings, resulting in a more subdued pick-up in private consumption, a delayed recovery and limited disinflationary pressures. Continued high savings by households over a longer period would translate into lower aggregate demand and inflation. Domestic GDP would therefore recover more slowly than assumed in the central scenario and world GDP would stand at 0.2% below the central scenario level in 2021, 0.7% below in 2022 and around 0.5% below in 2023 (Chart E). The impact on global inflation would be limited. It is worth noting that despite the downside risks to global output, the build-up of household savings may yield longer-term gains in terms of stronger household balance sheets (e.g. lower leverage) to withstand future adverse shocks.
The analysis presented in this box illustrates the risks to global GDP in different household savings scenarios. The extent to which households across advanced economies will spend excess savings on consumption goods is crucial for the global outlook and is tied to several factors, not least the evolution of the pandemic (including progress in domestic vaccination campaigns), households’ employment prospects (especially for those with more modest income levels) and expected fiscal policy stances.
Authors:

Maria Grazia Attinasi
Alina Bobasu
Ana-Simona Manu

The economies analysed are Australia, Canada, Japan, the United Kingdom and the United States.

See, for example, Fisher, J. D., Johnson, D.S., Smeeding, T. M and Thompson, J. P., “Estimating the marginal propensity to consume using the distributions of income, consumption, and wealth”, Journal of Macroeconomics, Vol. 65, 2020.

See Table 3.2 of “Family spending workbook 1: detailed expenditure and trends”, Office for National Statistics, 2021.

Survey of Consumer Expectations, Federal Reserve Bank of New York, March 2021.

See “How has Covid affected household savings?”, Bank of England, November 2020.

The Ricardian equivalence proposition states that in response to a debt-financed increase in government spending, households do not increase their consumption despite having to pay less taxes. Hence, they will save more. This is because households anticipate that an increase in public debt will have to be financed by higher taxes in the future. The Ricardian equivalence proposition hinges on the assumptions that households can borrow and lend freely and that taxes are non-distortionary.

See Beraja, M. and Wolf, C., “Demand Composition and the Strength of Recoveries”, working paper.

For these scenarios we only focus on the United States, the United Kingdom and Japan.

The simulations assume no monetary policy reactions in advanced economies and unchanged oil prices.

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The role of sectoral developments for wage growth in the euro area since the start of the pandemic

The economic consequences of and policy responses to the pandemic pose challenges for interpreting wage developments. Aggregate wage growth is mostly assessed in terms of compensation per employee or compensation per hour worked.[1] The coronavirus (COVID-19) pandemic has led to a substantial divergence between compensation per employee and compensation per hour. The high number of workers on job retention schemes played a decisive role in these developments, especially via the implications for hours worked per person. Such schemes tend to have a downward effect on compensation per employee, as employees usually retain their employment status but, in most countries, face pay cuts when enrolling in these schemes. Moreover, the benefits of such schemes are not included in statistical measures of compensation where they are directly paid to employees.[2] At the same time, such schemes have an upward effect on compensation per hour, as hours worked tend to be reduced far more strongly than pay.
Year-on-year growth in compensation per employee (CPE) dipped sharply at the start of the pandemic but was back at pre-crisis rates in the first quarter of 2021. This strong V-shaped pattern obviously mirrors the pattern of economic activity, but it is unusual in the sense that it has been driven mainly by adjustments in compensation and less by changes in employment (Chart A). By comparison, while the number of employees declined at a rate comparable to that during the great financial crisis, the total compensation of employees was clearly adjusting much more than back then. This can be explained by the more decisive role that job retention schemes played this time round. The schemes helped to preserve the employment status of employees but also came with some reduction in compensation as, in most countries, not all of the lost hours were reimbursed through the schemes and payments from these were mostly recorded as transfers rather than compensation.[3] As the economy recovered, hours worked normalised and the recourse to job retention schemes receded – leading to an adjustment in compensation. In the first quarter of 2021 zero annual growth of compensation and a still negative year-on-year growth rate in the number of employees brought CPE growth to 1.9% – close to its long-term average (since 1999) of 2.0%.

Chart A
Decomposition of growth in compensation per employee in the euro area
(annual percentage changes)
Sources: Eurostat and ECB staff calculations.
Notes: The latest observations are for the first quarter of 2021. For both panels, the series for employees is inverted, meaning that positive numbers reflect a reduction of the number of employees in year-on-year terms while negative numbers reflect an increase.

The movements in aggregate CPE growth conceal some notable sectoral differences (Chart B). With the onset of the crisis, wage growth slumped in the second quarter of 2020 to a similar extent in market services, industry (excluding construction) and construction. The third quarter saw a general recovery in wage growth which continued into early 2021 for industry and construction, while wage growth in market services experienced a second, albeit smaller, hit in the fourth quarter of 2020 as the pandemic necessitated a renewed period of lockdown that mainly affected service sector jobs. Within the services sector, non-market services stood out throughout the pandemic in the sense that wage growth remained close to its pre-crisis level until summer 2020 and even increased substantially in the second half of 2020 (reaching 3.7% in the fourth quarter) before falling back to 2.2% in the first quarter of 2021. Special bonuses in particular for employees in the health sector linked to their high workload, which were granted in many euro area countries, played an important role in the strong wage growth in non-market services in the second half of 2020. Overall, the dispersion of CPE growth has remained higher than during pre-pandemic times – underlining the importance of taking sectoral developments into account when analysing aggregate wage growth.

Chart B
Growth in compensation per employee in the euro area by main sector
(annual percentage changes)
Sources: Eurostat and ECB staff calculations.
Notes: The latest observations are for the first quarter of 2021. “Non-market services” includes public administration, defence, education, health and social work activities.

The differences in sectoral developments in CPE growth reflect the differences in the extent to which sectors were affected by the pandemic and the measures taken to contain it, in particular the recourse to job retention schemes. Contrary to previous crises, the pandemic hit the market services sector hardest, as a large part of its activity was especially affected by restrictions to physical mobility and lockdown measures. Harmonised data concerning the reliance on job retention schemes in the different sectors are not available for the whole euro area, but the relative adjustments in employment and hours worked per employee can provide some crude indication (see Chart C). In the second quarter of 2020 all sectors saw a large relative adjustment in hours worked per employee compared with employment. In construction, employment contracted only slightly, and the situation normalised again quite quickly from the third quarter of 2020 onwards. The industrial sector experienced a more substantial reduction in employment, which persisted until the first quarter of 2021, while hours worked per person normalised more quickly. The implied reduced recourse to job retention schemes was then visible in the continued recovery of compensation of employees. The market services sector was hit hardest with the largest losses in employment which, like those in industry, persisted until the first quarter of 2021. However, in contrast to the other sectors, hours worked per employee dipped again relative to employment in the fourth quarter of the year, implying a further decrease in compensation of employees in line with a renewed recourse to job retention schemes. There were no employment losses in non-market services during the crisis, and the reduction in hours worked per employee in the second quarter of 2020 was accompanied by only small losses in compensation of employees. This sector was characterised by considerable resilience in compensation of employees and wage growth relative to the other sectors.

Chart C
Sectoral developments in compensation per employee growth in the euro area
(annual percentage changes)
Sources: Eurostat and ECB staff calculations.
Notes: The latest observations are for the first quarter of 2021. “Non-market services” includes public administration, defence, education, health and social work activities.

The asymmetric impact of the pandemic is even more visible when distinguishing within the market services sector between high and low-contact services. As the restrictions introduced to contain the spread of the pandemic were aimed at reducing especially interpersonal contacts, high-contact services (including wholesale and retail trade, transport, accommodation and food service activities) suffered more than low-contact services (such as information and communication, finance and insurance, and real estate, among others). While CPE growth was hit substantially in both sub-sectors during 2020, the effects were far more pronounced for high-contact services owing to a much higher reduction in hours worked per employee given the stronger role of job retention schemes. CPE growth in low-contact services has been positive again since the third quarter of 2020, standing at 2.0% in the first quarter of 2021, up from 0.8% and 1.0% in the third and fourth quarters of 2020 respectively. However, CPE growth continued to be negative for high-contact services, as a result of pandemic restrictions affecting especially this sub-sector (Chart D).

Chart D
Wage developments in high and low-contact market services in the euro area
(annual percentage changes)
Sources: Eurostat and authors’ calculations.
Notes: “High-contact market services” comprises wholesale and retail trade, transport, accommodation and food services. “Low-contact market services” corresponds to market services excluding high-contact market services. The latest observations are for the first quarter of 2021.

The effects of the pandemic on growth in compensation per employee are expected to continue shaping wage developments in 2021 and across all sectors. The massive decrease in CPE growth in the second quarter of 2020 can be expected to lead to strong base effects in CPE growth in the second quarter of 2021. Such upward base effects can be expected to be strongest in the sectors hit most severely during the pandemic – namely high-contact services – but will also play an important role in other sectors. As labour markets are projected to gradually recover over the coming years and the impact of job retention schemes wanes, developments in compensation per employee should normalise in the main sectors of the economy. Going forward, a key question is whether sectoral wage negotiations will aim to make up for temporary losses in compensation during the pandemic at least partly and in some sectors, which could add to wage growth over the next years.
Authors:

Gerrit Koester
Eduardo Gonçalves

Compliments of the European Central Bank.

See the box entitled “Assessing wage dynamics during the COVID-19 pandemic: can data on negotiated wages help?”, Economic Bulletin, Issue 8, ECB, 2020.

See also the box entitled “Short-time work schemes and their effects on wages and disposable income”, Economic Bulletin, Issue 4, ECB, 2020.

See the box entitled “Developments in compensation per hour and per employee since the start of the COVID‑19 pandemic” in the article entitled “The impact of the COVID-19 pandemic on the euro area labour market”, Economic Bulletin, Issue 8, ECB, 2020.

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Assessing Progress as the Economy Moves from Reopening to Recovery, Governor Lael Brainard at “Rebuilding the Post-Pandemic Economy” 2021 Annual Meeting of the Aspen Economic Strategy Group, Aspen, Colorado |
The economy is reopening, consumer spending is strong, and hundreds of thousands of workers are finding jobs in the hard-hit leisure and hospitality sector each month. Pent-up demand has outstripped capacity in some sectors, as businesses that had pared back to survive the pandemic are encountering bottlenecks as they rehire and restock.1 These mismatches have made it more difficult to interpret the first few months of reopening data.
The second quarter of 2021 saw a large wave of demand buoyed by fiscal transfers, resulting in annualized real personal consumption expenditures (PCE) growth of 11.8 percent. Real gross domestic product grew at an annual rate of 6.5 percent in the second quarter of 2021, slightly less than many forecasters had projected, as that strong consumer demand outstripped production, resulting in a significant decline in inventories.
The tailwinds to growth from the fiscal stimulus during the first half are shifting to headwinds that will continue through the remainder of 2021 and 2022. Even so, pent-up consumption and full reopening are expected to more than offset fiscal headwinds in the second half such that PCE is expected to grow at a robust rate, and growth is expected to remain strong through the remainder of the year. By the end of the year, the U.S. economy is expected to achieve average annualized growth of 2.2 percent since the onset of COVID-19—slightly above most estimates of longer-term potential output growth. In short, growth this year is expected to compensate fully for last year’s sharp contraction—as a result of the strong policy response, effective vaccines, and the resilience and adaptability of American households, workers, and businesses.
While we are seeing progress on employment, joblessness remains high and continues to fall disproportionately on African Americans and Hispanics and lower-wage workers in the services sector.
Last December, the Committee indicated that asset purchases would continue until substantial further progress toward our employment and inflation goals had been achieved. The June data showed that there is a shortfall of 6.8 million jobs relative to the pre-pandemic level and 9.1 million jobs relative to the pre-pandemic trend, respectively. The employment-to-population (EPOP) ratio is 3.2 percentage points short of its pre-pandemic level for prime-age workers, a group that is not affected by the elevated level of early retirements during the pandemic. Thus, as of June, we had closed between one-fourth and one-third of the employment shortfall relative to last December according to a variety of measures.
Although the EPOP ratio for Black individuals has improved more strongly than the overall ratio over the course of 2021, closing about 40 percent of the December gap, it remains more than 3 percentage points below its pre-pandemic level and more than 2 percentage points below the current level of the EPOP ratio for white individuals.
Currently, it is difficult to disentangle the effects on labor supply of caregiving responsibilities brought on by the pandemic, fears of contracting the virus, and the enhanced unemployment insurance that was designed in part to address such constraints. Importantly, I expect to be more confident in assessing the rate of progress once we have data in hand for September, when consumption, school, and work patterns should be settling into a post pandemic normal.
I fully expect progress to continue, ultimately leading to a labor market as strong or stronger than we saw before the pandemic. Looking ahead, if jobs were to continue to increase at the second-quarter average monthly pace, about two-thirds of the outstanding job losses as of December 2020 and nearly half of the gap relative to the pre-pandemic trend would be made up by the end of 2021. If, instead, the rate of job growth were to accelerate notably, those levels could be reached somewhat sooner.
Today’s data showed that core PCE inflation rose 0.45 percent in June, once again driven by outsized contributions from a handful of categories. New and used vehicles contributed just under 40 percent of the June increase in core PCE, while price increases for travel-related items like hotels, airfares and rental cars contributed another 25 percent.2 All told, price increases associated with vehicles and vacations, categories that comprise about 8 percent of the core PCE basket, were responsible for over 60 percent of the June core PCE price increase.
Recent high inflation readings reflect supply–demand mismatches in a handful of sectors that are likely to prove transitory. In assessing inflation, an annualized 24-month measure that looks through the steep declines and subsequent rebound in prices in categories affected by the pandemic currently has core PCE inflation running at 2.3 percent and headline PCE inflation running at 2.4 percent. It is reasonable to expect these measures to remain near those levels for much of the rest of the year. By comparison, this 24-month measure was running at 1.6 percent in December 2020.
I am attentive to the risk that inflation pressures could broaden or prove persistent, perhaps as a result of wage pressures, persistent increases in rent, or businesses passing on a larger fraction of cost increases rather than reducing markups, as in recent recoveries. I am particularly attentive to any signs that currently high inflation readings are pushing longer-term inflation expectations above our 2 percent objective.
Currently, I do not see such signs. Most measures of survey- and market-based expectations suggest that the current high inflation pressures are transitory, and underlying trend inflation remains near its pre-COVID trend. Since the June FOMC meeting, five-year, five-year-forward inflation compensation based on Treasury Inflation-Protected Securities has declined a little less than 20 basis points, on net, and it currently stands at 2.2 percent, at the low end of its range of values prior to the 2014 decline. The second-quarter reading from the Federal Reserve Board’s index of common inflation expectations stands at 2.05 percent, which is at the bottom of the range that prevailed from 2008 to 2014, when 12-month total PCE inflation averaged 1.7 percent.3
Many of the forces currently leading to outsized gains in prices are likely to dissipate by this time next year. Current tailwinds from fiscal support and pent-up consumption are likely to shift to headwinds, and some of the outsized price increases associated with acute supply bottlenecks may ease or partially reverse as those bottlenecks are resolved. Lumber prices have fallen, wholesale used car prices appear to have peaked, and auto semiconductor production is projected to expand.
While there is good reason to expect that the inflation dynamics that prevailed for a quarter-century will reassert themselves on the other side of reopening, I will remain vigilant to any signs that inflationary pressures are likely to prove more persistent or that expectations are moving above target. If inflation moves persistently and materially above our target, we would adjust policy to guide inflation gently back to target.
There are risks on both sides of the outlook. There are upside risks to consumption spending associated with the high level of households’ savings. There are downside risks associated with the Delta variant. While the economy’s momentum is strong, vaccination rates remain low in some areas, and fears related to the Delta variant may damp the rebound in services and complicate the return to in-person school and work in some areas and slow the rotation from goods to services that account for three- fourths of the shortfall in jobs
In coming meetings, we will continue to assess progress and the conditions under which it will be appropriate to start paring back the pace of our asset purchases. Twenty-four-month core PCE inflation is now running at a 2.3 percent average annualized rate. In contrast, employment is still down by 6.8 million to 9.1 million relative to its pre-COVID level and trend, respectively, and it has closed about one-fourth to one-third of its December gap. The determination of when to begin to slow asset purchases will depend importantly on the accumulation of evidence that substantial further progress on employment has been achieved. As of today, employment has some distance to go.
It is important to emphasize that the achievement of substantial progress that will determine when the Committee starts reducing the pace of asset purchases is distinct from the maximum employment and inflation outcomes that are in the forward guidance for the policy rate. Remaining attentive to changing conditions and steady in our step-by-step approach to implementing policy under our new framework should ensure that the economy’s momentum is sufficient when tailwinds shift to headwinds to achieve and sustain maximum employment and inflation robustly anchored at 2 percent.
Compliments of the U.S. Federal Reserve.

1. I am grateful to Kurt Lewis for his assistance in preparing these remarks. These views are my own and do not necessarily reflect those of the Federal Reserve Board or the Federal Open Market Committee. Return to text

2. The notable gap between the June PCE reading and the CPI reading is due, in part, to the lower weighting of vehicles in the PCE measure. Return to text

3. For more information about the index of common inflation expectations (CIE), see Hie Joo Ahn and Chad Fulton (2020), “Index of Common Inflation Expectations,” FEDS Notes (Washington: Board of Governors of the Federal Reserve System, September 2), https://doi.org/10.17016/2380-7172.2551. The CIE data are available through the second quarter on the Board’s website at https://www.federalreserve.gov/econres/notes/feds-notes/research-data-series-index-of-common-inflation-expectations-20210305.htm. Return to text

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History moves in uneven steps. Just as the telegraph erased time and distance in the 19th century, today’s innovations in digital money may bring significant changes in the way we lead our lives. The shift to electronic payments and social interactions brought on by the pandemic may cause similarly rapid and widespread transformations.

‘The challenges are significant, and so is the potential reward. But policy action must begin immediately.’

But we must look beyond the dazzle of technology and the alluring image of futuristic payment services. At the IMF, we must identify and help countries solve the deeper policy tradeoffs and challenges that are arising.
The rapid pace of change is a call to action—for countries to guide, and not be guided by, today’s transformations. It is also important for the IMF to engage early with countries, and usher in reforms that will contribute to the stability of the international monetary system, and foster solutions that work for all countries. There is a window of opportunity to maintain control over monetary and financial conditions, and to enhance market integration, financial inclusion, economic efficiency, productivity, and financial integrity. But there are also risks of stepping back on each of these fronts. We must enact the right policies today to reap the gains tomorrow.
We emphasize this in two papers published today, one on the new policy challenges, and one on an operational strategy for the Fund to engage with countries on the digital money revolution.
Digital money developing rapidly
Digital forms of money are diverse and evolving swiftly. They include publicly issued central bank digital currencies (CBDC)—think of these as digital cash, though not necessarily offering the same anonymity to avoid illicit transfers. Private initiatives are also proliferating, such as eMoney (like Kenya’s mobile money transfer service MPesa) and stablecoins (digital tokens backed by external assets, like USD-coin and the proposed Diem). These are digital representations of value that can be transferred at the click of a button, in some cases across national borders, as simply as sending an email. The stability of these means of payment, when measured in national currencies, varies significantly. The least stable of the lot, which hardly qualify as money, are cryptoassets (such as Bitcoin) that are unbacked and subject to the whims of market forces.
These innovations are already a reality, and growing rapidly. According to IMF data, CBDCs are being closely analyzed, piloted, or likely to be issued in at least 110 countries. Examples range from the Bahamas’ Sand Dollar already in use, to the People’s Bank of China’s eCNY pilot project, to countries like the United States where the benefits and drawbacks of a digital dollar are still being studied. Stablecoins, still esoteric two years ago, tripled in value in the last six months (from $25 billion to $75 billion), while cryptoassets doubled (from $740 billion to $1.4 trillion). And adoption is global. eMoney accounts are not only growing much more rapidly in low- and middle-income countries than in the rich ones, but are now also more numerous. Africa, in particular, is leading the way.
Opportunities are immense. A local artisan can receive payments more cheaply, potentially from foreign customers, in an instant. A large financial conglomerate can settle asset purchases much more efficiently. Friends can split bills without carrying cash. People without bank accounts can save securely and build transaction histories to obtain micro-loans. Money can be programmed to serve only certain purposes, and be accessed seamlessly from financial and social media applications. Governments can tax and redistribute revenues more efficiently and transparently.
Policy implications—opportunities and challenges ahead
We may well reap these benefits, but we must be aware of risks, and—importantly—of the bigger policy implications and tradeoffs. The challenges to policymakers are stark, complex, and widespread.
The most far-reaching implications are to the stability of the international monetary system. Digital money must be designed, regulated, and provided so that governments maintain control over monetary policy to stabilize prices, and over capital flows to stabilize exchange rates. These policies require expert judgment and discretion and must be taken in the interest of the public. Payment systems must grow increasingly integrated among countries, not fragmented in regional blocs. And it is essential to avoid a digital divide between those who gain from digital money services and those left behind. Moreover, the stability and availability of cross-border payments can support international trade and investment.
There are also implications for domestic economic and financial stability. The public and private sectors should continue to work together to provide money to end-users, while ensuring stability and security without stifling innovation. Banks could come under pressure as specialized payment companies vie for customers and their deposits, but credit provision must be sustained even during the transition. And fair competition must be upheld—not an easy task given the large technology companies entering the world of payments. Moreover, governments should leverage digital money to facilitate the transfer of welfare benefits or the payment of taxes. Scope even exists to bolster financial inclusion by decreasing costs to access payment and savings services.
Finally, new forms of money must remain trustworthy. They must protect consumers’ wealth, be safe and anchored in sound legal frameworks, and avoid illicit transactions.
The challenges are significant, and so is the potential reward. But policy action must begin immediately. This is the time to establish a common vision for the future of the international monetary system, to strengthen international collaboration, and to enact policies and establish legal and regulatory frameworks that will drive innovation for the benefit of all countries while mitigating risks.
Choosing the right path now is critical. Regulation, market structure, product features, and the role of the public sector can quickly ossify around less desirable outcomes. Backtracking later can be very costly.
The IMF has a mandate to help ensure that widespread adoption of digital money fosters domestic economic and financial stability, and the stability of the international monetary system. We plan to engage regularly with country authorities to evaluate country-specific policies, provide capacity development to avoid a digital divide, and develop analytical foundations to identify policy options and tradeoffs.
To do so, the IMF must deepen its expertise, widen its skillset, ramp up resources, and leverage its near universal membership. Still, we cannot do this alone. The challenges are so complex and multifaceted, that collaborating closely with other stakeholders is necessary. The World Bank, the Bank for International Settlements along with its Innovation Hub, international working groups and standard-setting bodies, as well as national authorities, are all complementary partners, each with its specific mandate and skillset. By joining hands, we will help households and firms leverage the benefits and avoid the pitfalls of the digital money revolution.
Authors:

Tobias Adrian
Tommaso Mancini-Griffoli

Compliments of the IMF.
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