Most of the world operates under the central banking system. Specifically, the money supply is tied to fractional reserve banking. This creates both central bank money and commercial bank money.
Under the Federal Reserve System, the central bank is responsible for monetary policy. Through their actions, they can affect the monetary base. This is done through the expansion or contraction of banknotes, i.e. cash, or reserves. They also try to affect things by maneuvering interest rates in an effort to stimulate or restrict lending by the commercial banks.
Many central banks feel this is the safest form of money since the risk associated with it is lessened. The public does not have access to this hence the view that it is safe. Only the depository institutions can access this through their master accounts.
Central Bank Money is a liability on the central bank's balance sheet. This mirrors commercial bank money) which is a liability on those balance sheets. The liability is generated to match the accompanying asset in accordance with double-entry accounting.
Central banks are always striving for stability of the currency. This is done in relation to the price of goods and services as well as the currencies of other nations. Over the years, a number of mechanisms were employed to achieve this end. One of the more popular methods is Quantitative Easing (QE). This was started by the Bank of Japan and spread throughout the world.
Essentially, QE is the swapping of Central Bank Money for securities (Treasury or Mortgage Backed). Through this process, the idea is to raise the lending limits of commercial banks. This will, in theory, put more money in the real economy, this creating economic expansion.
Of course, there is always a fine line between inflation of the currency resulting in economic growth as compared to seeing an increase in prices. Here is where the central banks are consistently trying to maintain the stability. When it comes to currency, volatility is a negative.
Since commercial banks are the ones that affect the money supply (not the monetary base), we can see how increasing the lending limits could affect the economy. Unfortunately, the history of QE so far is that even with the increase in Central Bank Money, that has not translated into the same in the commercial bank money. The reason for this is banks make less loans when economic conditions deteriorate.
Central Bank Digital Currency
A lot is being made of the prospect of central banks introducing a central bank digital currency (CBDC). This is the idea that a digital form of the currency is creating, compensating for the loss of cash usage.
When it comes to CBDCs, a distinction has to be made. These can be in two forms:
- wholesale - a token that is for inter-bank usage
- retail - a token that is used by the general public
Central bank reserves are effectively a stablecoin. This is a bank instrument that is peg to the legal tender. For the Fed, a reserve is worth $1 and can be redeemed by the commercial bank for a banknote. A wholes CBDC would effectively replace this.
The question is how effective the network would be. Globally, one of the drawbacks to international transactions is the settlement times because the networks are lacking as compared to others. This is why many feel that blockchain could be a solution.
Retail CBDC is another question altogether. As a replacement for cash, this will fit within the existing legal framework. If it encroached upon the commercial banking system, legal disputes could result. Under U.S. law, Fed liabilities are not legal tender.
Most of the proposals relating to the major currencies are to operate under a two-tiered system, maintaining debt base money that we are operating under. The general public, individuals and businesses, would be account based whereas tokens would be utilized in lieu of cash.