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The Overwhelming Case for CBDCs

There is growing evidence to suggest that, in the coming years, the US Federal Reserve and other central banks will find themselves back where they were before the pandemic, with their primary policy instrument constrained by the natural real interest rate. Fortunately, this old problem now has a prudent technological solution.

NEW YORK – In its latest World Economic Outlook, the International Monetary Fund establishes a plausible case that once inflation has been squeezed out of the system, interest rates in the advanced economies (and in many emerging markets) will return toward their extremely low pre-pandemic levels. That would be in keeping with the downward trend in the natural real interest rate since the early 1980s, itself the result of aging populations and disappointing total factor productivity growth.

The natural real interest rate reflects the balance of planned savings and capital formation under the theoretical conditions of full employment and on-target inflation. True, nothing is ever certain in the real world. The larger government budget deficits become, the more upward pressure there will be on the natural rate. While aging societies tend to save more, truly old societies save less. And one also must consider the effects of a possible great “decoupling” of the global economy and the rise of US-centered and China-centered blocs. That could well reduce capital inflows for the advanced economies, boosting their natural rates.

Still, on balance, it is reasonable to assume that in two or three years, we will return to a world in which advanced-economy central banks’ nominal policy rates are regularly constrained by the effective lower bound (ELB). A zero nominal interest rate on currency (cash) sets a near-zero floor under the central bank policy rate. A very low natural real interest rate and low inflation make it likely that the ELB will be a binding constraint. Even though nominal policy rates have risen significantly since 2020, with the US Federal Reserve’s policy rate now at 4.75-5%, real (inflation-adjusted) short-term policy rates are still barely positive in the United States, and they remain materially negative in most other advanced economies. According to the Federal Reserve Bank of Cleveland, the US ten-year real interest rate was only around 2%, and that was its highest level since the 2008 financial crisis.