How politics are affecting the design of a Fed digital dollar

According to Federal Reserve chair Jerome Powell, the Fed will not issue public digital currency without congressional approval. But within Congress, there are competing visions for public digital currency design.  

The “Banking for All Act,” sponsored by Sen. Sherrod Brown (D-Ohio), requires Federal Reserve Banks to make public digital currency accounts freely available to all. An alternative bill, sponsored by Rep. Tom Emmer (R-Minn.) prohibits the Federal Reserve Banks from directly issuing digital currency to the public. Should the Fed decide to issue it, the ultimate design of a Fed digital dollar could well depend on which party controls the Congress. 

The Fed issues two forms of central bank money: paper Federal Reserve notes and digital dollars held as reserve balances in master accounts at Federal Reserve banks. The latter can only be held by banks and other specialized financial institutions. A new public digital currency would allow the public to own Fed digital dollars. There are many ways public digital currency, if issued, could be designed and the design could have wide-ranging implications for the financial system. 

Brown’s bill requires Federal Reserve district banks and member banks to offer a new type of public digital currency account free of charge to the public. These “digital wallets” called “FedAccounts” would hold Fed digital dollars, pay interest and provide all of the services typically associated with a full-service commercial bank checking account — a debit card, ATM access and electronic bill paying services — with no minimum or maximum balance requirements. The bill requires large banks to absorb the cost of offering FedAccounts while banks smaller than $10 billion in assets would have their operating costs reimbursed by the Fed. 

Emmer’s bill prohibits Federal Reserve Banks from offering products or services to individuals, which would preclude FedAccounts. In his view, this restriction will ensure that public digital currency, should it be issued, provides privacy and services that mimic private stablecoins. According to Emmer, “any [public digital currency] implemented by the Fed must be open, permissionless, … accessible to all, transact on a blockchain that is transparent to all, and maintain the privacy elements of cash.”  

Notwithstanding Emmer’s preferences for design, his bill need not require a public digital currency to be a blockchain token. Public digital currency could be issued using specialized accounts at depository institutions that have master accounts at the Fed. These account balances would be matched dollar-for-dollar with segregated reserves posted by the depository institution at a Federal Reserve Bank. This form would not necessarily be traded over the internet, but could instead use existing bank payments system infrastructure. Indeed, the recent Federal Reserve Bank of Boston MIT study tested such a design.   

Perhaps the most important feature of public digital currency design is its ability to pay interest. Free FedAccounts that pay positive interest would be enormously popular. Paper currency pays no interest, so a public digital dollar that is a direct substitute for currency should not either. Few would hold large Fed digital dollar balances that pay negative interest if cash and positive yield alternatives exist. A public digital currency that pays positive interest will easily dominate cash and private stablecoins as well because most stablecoins do not pay interest or dividends to avoid Securities Exchange Commission registration and reporting requirements. 

Congressional views regarding public digital currency design reflect differences in legislative priorities. However, legislative proposals that focus on making them free and universally available to improve financial inclusion or, alternatively, restrict their design to ensure privacy, ignore evidence that public digital currency design may not be the best way to accomplish either of these goals.  

The past decade has seen a marked decline in the unbanked problem. According to the FDIC,” The proportion of U.S. households that were unbanked in 2019 — 5.4 percent — was the lowest since the survey began in 2009.”  Moreover, FDIC found that “about half of the decline in the unbanked rate … was associated with improvements in the socioeconomic circumstances of U.S. households… .” Any benefits that flow to the unbanked from the Banking Act for All would likely be overwhelmed by the costs it would impose on others by depressing economic growth. This public digital currency design would stifle economic growth by draining deposits from the banking system, thereby reducing the availability and raising the cost of bank credit. 

Similarly, banning FedAccounts on privacy grounds ignores the fact that, even without them, the government has been able to limit targeted businesses and citizens from accessing bank credit and the payments system, even when targeted individuals’ transactions were perfectly legal. For example, in operation “Choke Point,” the Department of Justice and FDIC pressured banks to end relationships with fully lawful businesses like check cashiers, payday lenders, ammunition and gun merchants, and adult entertainment outlets because these businesses were disfavored by the Obama administration. Banks were forced to terminate relationships under the guise that these businesses were “high risk” and created “reputational risk” for FDIC-insured banks. 

Recent historical events show that legislative goals like providing financial services to the unbanked or safeguarding financial system access and privacy are unlikely to be best achieved by restricting public digital currency design. Such policy concerns are better addressed outside of that debate.      

If passed into law, either of these legislative proposals will shape the design of public digital currency. This design has far-reaching repercussions, including the availability of bank credit, the size of the Fed’s balance sheet and the development of new payments system technologies. Designs should not preclude private sector payment system innovations that maintain the current level of transactional privacy and hold promise to improve access for those that are currently unbanked. It would be shortsighted to legislatively restrict the design to satisfy a narrow set of political goals or preclude private sector innovation.   

What is clear is that public digital currency design preferences are split along party lines. Since the Fed has yet to seek permission to issue digital dollars, control of Congress is potentially the most important factor influencing their design.

Paul H. Kupiec is a senior fellow at the American Enterprise Institute (AEI), where he studies systemic risk and the management and regulations of banks and financial markets.