A digital loonie among many digital currencies prospects and outlook

Siklos, Pierre L. Working Paper A digital loonie among many digital currencies prospects and outlook CIGI Papers, No. 269 Provided in Cooperation with: Centre for International Governance Innovation (CIGI), Waterloo, Ontario Suggested Citation: Siklos, Pierre L. (2022) : A digital loonie among many digital currencies prospects and outlook, CIGI Papers, No. 269, Centre for International Governance Innovation (CIGI), Waterloo (Ontario) This Version is available at: https://hdl.handle.net/10419/299741 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Siklos CIGI Papers No. 269 — October 2022 A Digital Loonie among Many Digital Currencies Prospects and Outlook Pierre L. Siklos Copyright © 2022 by the Centre for International Governance Innovation The opinions expressed in this publication are those of the author and do not necessarily reflect the views of the Centre for International Governance Innovation or its Board of Directors. For publications enquiries, please contact [email protected]. This work is licensed under a Creative Commons Attribution — Non-commercial — No Derivatives License. To view this license, visit (www.creativecommons.org/licenses/by-nc-nd/3.0/). For re-use or distribution, please include this copyright notice. Printed in Canada on Forest Stewardship Council® certified paper containing 100% post-consumer fibre. Centre for International Governance Innovation and CIGI are registered trademarks. 67 Erb Street West Waterloo, ON, Canada N2L 6C2 www.cigionline.org About CIGI The Centre for International Governance Innovation (CIGI) is an independent, non-partisan think tank whose peer-reviewed research and trusted analysis influence policy makers to innovate. Our global network of multidisciplinary researchers and strategic partnerships provide policy solutions for the digital era with one goal: to improve people’s lives everywhere. Headquartered in Waterloo, Canada, CIGI has received support from the Government of Canada, the Government of Ontario and founder Jim Balsillie. À propos du CIGI Le Centre pour l’innovation dans la gouvernance internationale (CIGI) est un groupe de réflexion indépendant et non partisan dont les recherches évaluées par des pairs et les analyses fiables incitent les décideurs à innover. Grâce à son réseau mondial de chercheurs pluridisciplinaires et de partenariats stratégiques, le CIGI offre des solutions politiques adaptées à l’ère numérique dans le seul but d’améliorer la vie des gens du monde entier. Le CIGI, dont le siège se trouve à Waterloo, au Canada, bénéficie du soutien du gouvernement du Canada, du gouvernement de l’Ontario et de son fondateur, Jim Balsillie. Credits Managing Director of Digital Economy Robert Fay Project Manager Jenny Thiel Publications Editor Susan Bubak Senior Publications Editor Jennifer Goyder Graphic Designer Brooklynn Schwartz Table of Contents vi About the Author vi Acronyms and Abbreviations 1 Executive Summary 2 Introduction 2 Driving Forces behind Retail CBDC 5 The Domestic and International Dimensions of Retail CBDC 8 Institutional Capacity, Transactions Costs and Retail CBDC 17 Currency Substitutability: A Threat to the Loonie? 18 Conclusions and Policy Implications 21 Works Cited vi CIGI Papers No. 269 — October 2022 • Pierre L. Siklos About the Author Pierre L. Siklos is a CIGI senior fellow who specializes in macroeconomics, with an emphasis on the study ofinflation, central banks and financial markets.He also conducts research in applied time series analysis. His research has been published in a number of international journals, and he has been a consultant to a variety of institutions and central banks. His work has been widely cited in several macroeconomics and econometrics textbooks.Pierre has also been a visiting lecturer at several universities in Europe and North America as well as in Australia and New Zealand. His research has been funded by domestic and international agencies. In 1999, he was an Erskine Fellow at the University of Canterbury in New Zealand, and in 2009, he was a William Evans Fellow at the University of Otago in New Zealand. Pierre was Wilfrid Laurier University’s (WLU’s) University Research Professor for the academic year 2000– 2001, the director of the Viessmann European Research Centre at WLU from 2005 to 2014, and a member of the Czech National Bank’s Research Advisory Committee between 2012 and 2018. In 2008, Pierre was chair of the Bundesbank Foundation of International Monetary Economics at the Freie Universität Berlin in Germany. He is a guest professor at the Westfälische Wilhelms-Universität Münster in Germany, a research fellow of the South African Reserve Bank and Stellenbosch University in South Africa and has been appointed Fondation France-Japon/ Banque de France Fellow for 2021–2022. Acronyms and Abbreviations AEs advanced economies ATM automated teller machine BIS Bank for International Settlements CBDC central bank digital currency CBI central bank independence COVID-19 coronavirus disease 2019 EMEs emerging market economies EPU economic policy uncertainty FDI foreign direct investment FSB Financial Stability Board G20 Group of Twenty IMF International Monetary Fund 1A Digital Loonie among Many Digital Currencies: Prospects and Outlook Executive Summary Interest in digital currencies parallels growing interest in digitalization more generally. Digitalization, strongly encouraged by the coronavirus disease 2019 (COVID-19) crisis, has advanced plans made by many central banks to introduce a retail central bank digital currency (CBDC). This paper sets out to explore two major forces that will dictate the emergence, spread and eventually the success of retail CBDC globally: first, the potential for a foreign retail CBDC to displace existing domestic currencies and, second, the scope for international cooperation in the rollout of retail CBDC. The paper identifies select economic and political factors that may explain the potential for shifts in currency holdings. For some countries, persistently poorly managed macroeconomic policies might encourage an even stronger shift toward alternative, more stable currencies, especially if they are available in digital form. Additionally, if the promised convenience, lower transactions costs or even the possibility of earning a return on a digital equivalent of cash emerge, then these features may also generate a shift toward the holding of more historically stable and widely used currencies. These are some of the international implications from the introduction of retail CBDC. It also remains to be seen whether, domestically, the composition of means of payment will be redistributed away from existing forms of payments (i.e., cards, mobile, app-based arrangements). While the foregoing considerations may dictate the demand for retail CBDC, each country’s ability to successfully create a homegrown retail CBDC will, first and foremost, depend on the quality and sophistication of domestic institutions. Institutional capacity will largely influence whether launching a digital currency is even feasible. Institutional capacity is meant to reflect resilience in the face of the “shock” that the introduction of a retail CBDC might represent. Because advocates of retail CBDC tout its global benefits, while acknowledging that its existence could constrain the space to carry out domestic economic policy, the possibility exists that a small number of economically and systemically important economies will threaten others. However, there is scope for groups of smaller countries and diverse groups to serve as counterweights to the actions of more powerful economies. The paper will seek to identify areas where agreement on the deployment of a retail CBDC is most likely, as well as potential sources of conflict. What do the foregoing developments portend for the prospects of a digital Canadian dollar (or digital “loonie”)? The tried and tested rule that a country should keep its economic house in order is likely to prevail. Moreover, the success of any digital loonie will need to be backed up by the ability of the authorities to provide holders with confidence and trust in the digital technology that will be employed. What is far less certain is how technical change, together with uncertain geopolitics, will play out. Policy makers will be challenged to develop new or better macroprudential tools to prevent any potential fallout from the “globalization” of retail CBDC. The precise details are beyond the scope of this paper, although some very broad guiding principles are provided. That said, there is a large shadow looming over the potential and promise of retail CBDC, namely, the global community’s ability to reach agreement on the deployment and rules about international movements in digital currencies. Indeed, the prospect of retail CBDCs having a role beyond complementing existing notes and coins — as a tool of monetary policy — is a policy discussion that needs to take place immediately. There are also governance implications to consider for monetary authorities. Declarations by central banks that planned retail CBDCs are not intended to have monetary policy implications are not enough. The time to revisit some aspects of central bank governance and the conduct of monetary policy is now. 2CIGI Papers No. 269 — October 2022 • Pierre L. Siklos Introduction Digitalization, in response to the COVID-19 crisis, has caused many central banks to further develop their plans to introduce a digital currency. At the outset, it is worth mentioning that observers often downplay the distinction between retail and wholesale forms of digital financial transactions. The latter have evolved considerably over the past several years and, while one element of wholesale digital transactions has been much in the news recently,1 the future battle is largely about digital currencies to be used by individuals as a complement to existing notes and coins. Indeed, for some time now, analysts have even predicted that conventional forms of cash are likely to disappear (for example, see Barrett 2021). Even if current trends suggest this may eventually happen (see below), reports about the death of cash “are greatly exaggerated,” to paraphrase the famous quote. The following discussion will focus exclusively on digital currencies issued by central banks for retail use, henceforth retail CBDCs.2 Moreover, this paper assumes that a retail CBDC is, at most, intended to complement notes and coins in circulation. The author recognizes the possibility that a retail CBDC can earn interest or incur a penalty rate, but these considerations are intended to play different, but potentially important, future roles in the analysis below. Moreover, central banks around the world have made it clear that, at the outset, only the narrowest form of retail CBDC will first be introduced. Other implications follow from the approach 1 Namely,thebanningofRussianfinancialinstitutionsfromSWIFT(the SocietyforWorldwideInterbankFinancialTelecommunication)network. Forexample,seeKowsmannandTalley(2022).Theusualthresholds beyond which transactions are labelled as wholesale as opposed to retailcanrangefrom$10,000to$100,000(alldollarfiguresinUS dollars),dependingonthecountryandthefinancialinstrumentin question. The Swiss National Bank, among other central banks, is already experimentingwiththisformofpayment(seeBankforInternational Settlements[BIS],SIXGroupAGandSwissNationalBank2020).Both alternatives have attracted considerable attention from policy makers because there is scope to avoid using central bank-issued money. It also raises the potential to shift business away from the banking sector to non-bankinstitutions.SeeWaller(2021)andUSSecuritiesandExchange Commission(2021). 2 KiffmeisterChronicles(kiffmeister.com)providesregularupdatesof jurisdictions where retail CBDCs are actively being considered. As of early May 2022, more than 80 central banks are considering the possibility of introducing a retail CBDC. taken in the present paper, and a more complete explanation is provided in the next section.3 Political and economic motives are also critically important, even if technical and legal considerations are some distance from being overcome (for example, see Arner et al. 2020; BIS, SIX Group AG and Swiss National Bank 2020). International cooperation will be essential (for example, see Committee on Payments and Market Infrastructures 2020). Why? A retail CBDC has raised the potential of a reduction in transactions costs and to enhance the public’s ability to hold and trade in multiple currencies (namely, see European Central Bank 2020). Next, and equally germane to this paper, the possibility of currency substitution also dovetails nicely with the Group of Twenty’s (G20’s) continuing aspiration to enhance digitalization as a “tool” to improve economic performance and reduce inequality.4 Driving Forces behind Retail CBDC This paper sets out to explore two major forces that will dictate the emergence, spread and eventually the success of retail CBDC globally: first, the potential for a foreign retail CBDC to displace existing domestic currencies and, second, the scope for international cooperation in the rollout of retail CBDC. That said, a necessary first step is to also ask: What determines the importance of currency held as a proportion of a country’s GDP? Figure 1 plots the ratio of currency in circulation as a proportion of GDP for 18 countries. The COVID-19 pandemic is represented by the last observation (2020), which is when, at the time of writing, the available data ends. Only 10 countries are explicitly identified to avoid excessive clutter. Nevertheless, at least two important observations can be made based on the results. First, before the pandemic, other than in Sweden and the United States, currency-to-GDP ratios have remained stable or 3 Foreaseofexposition,itiseasiesttofirstthinkofretailCBDCasprimarily serving as a transaction medium. “Money,” of course, can also serve a “store of value” function. The author returns to this issue below. 4 See www.g20.org/prosperity.html. 9A Digital Loonie among Many Digital Currencies: Prospects and Outlook held is relatively high (right tail) or low (left tail). This permits us, for example, to investigate whether the role of institutional capacity is sensitive according to whether there is a built-in bias toward greater or lesser currency holdings. Overall, the results suggest that institutional factors go a long way to explaining aggregate currency holdings over the period considered. More importantly, perhaps, is the finding that almost all institutional factors matter across the G20 economies. In particular, if contract enforcement mechanisms are strong, that is, greater property rights protection exists, this raises the currency-to-GDP ratio. Notice also that response is much stronger in the right tail than in the left tail — a strong indication that a critical element in explaining money holdings are property rights. Financial globalization and the debt-to-GDP ratio also influence currency-holding behaviour, although the economic magnitudes of the estimated coefficients are relatively small. Nevertheless, it is interesting that more financial globalization reduces the demand for currency only at the median and in the right tail of the distribution of currency-to-GDP ratios. Hence, any shift away from holding currency may well be linked to enhancements of global rules to the extent that the globalization proxy is able to capture such influences. Perhaps surprisingly, inflation has little impact on currency holdings, although Table 1: Economic and Institutional Determinants of the Demand for Notes in Circulation Dependent Variable: Notes-to-GDP Ratio Variable Mean Median Right Tail Left Tail Per capita cards 0.71 (0.22)* 0.83 (0.17)* 0.70 (0.11)* 0.61 (0.07)* Contract intensive -28.74 (10.85)** -29.11 (6.85)* -40.39 (12.15)* -21.74 (3.71)* Financial globalization -0.06 (0.05) -0.08 (0.03)** -0.06 (0.03)* -0.06 (0.04) Debt-to-GDP ratio 0.03 (0.01)* 0.04 (0.01)* 0.03 (0.01)* 0.04 (0.02)** Inflation -0.25 (0.09)* -0.18 (0.05)* -0.09 (0.24) -0.26 (0.14)** Central bank resilience -2.95 (1.00)* -2.58 (0.51)* -5.16 (0.70)* -1.75 (0.75)** Excess number of crises -1.34 (0.51)** -1.72 (0.68)* -3.28 (1.53)** -1.02 (1.06) EMEs 1.94 (1.45) 1.42 (0.97) 2.22 (1.60) 2.14 (0.72)** Constant 37.67 (12.30) 37.52 (8.30) 53.88 (12.00)* 26.95 (3.39)* Cross-sections 18 18 18 18 Observations 121 121 121 121 R20.75 0.51 0.58 0.51 F/p-value 46.38 (0.00) 213.39 (0.00) 173.41 (0.00) 137.27 (0.00) Fixed effects No No No No Sources: Data on per capita cards from BIS Red Book (see www.bis.org/statistics/payment_stats.htm), contract intensive is based on Clague et al. (1999), financial globalization is based on the KOF’s index (see https://kof.ethz.ch/en/forecasts-and- indicators/indicators/kof-globalisation-index.html), inflation is annual rate of change in consumer prices from the BIS (see www.bis.org/statistics/cp.htm?m=2678), and central bank resilience and excess number of crises are from indicators constructed by Hartwell and Siklos (2022). Notes: Pooled least squares estimates. *, ** indicate statistical significance at the one percent and five percent levels, respectively. Standard errors in parentheses. R2 is the adjusted coefficient of determination. F/p-value is the test statistic for the joint statistical significance of the right-hand-side variables in the estimated specification. P-value is the statistical significance level of the test statistic. 10 CIGI Papers No. 269 — October 2022 • Pierre L. Siklos it is important to point out that the sample covers a period of relatively low and stable inflation.23 Next to contract intensity, the most important other determinant of cash holdings, as measured by coefficient size, is central bank resilience. This variable unambiguously suggests that more resilient central banks translate into greater cash holdings in relation to GDP. Although the coefficients are broadly comparable across the distribution of cash-to-GDP ratios in the 18 countries considered, clearly countries where relatively more cash is held are associated with the most resilient central banks. This finding, if it holds for a larger set of countries and over a longer sample, supports the important role that the reputation of the monetary authority plays in cash-holding behaviour. There is no reason to suggest that this relationship would become less important in a world with retail CBDC. Finally, and unsurprisingly, countries that experience an excessive number of financial crises are also where currency holdings are relatively smaller, although the effect is not significant where cash holdings are small (i.e., in the left tail), suggesting that individuals in these economies have already adjusted their cash-holding behaviour in the face of financial instability. Arguably, the finding that institutional capacity matters will play a role in the introduction and evolution of retail CBDC, but this result is somewhat silent about the potential for digital currencies to be used in cross-border transactions.24 Therefore, Table 2 considers the data on remittances, an important source of cross-border transactions.25 In particular, the table considers which private institutions intermediate transactions involving remittances. Next, since the promise of retail CBDC is that it has the potential to reduce transactions costs, as well as complete transfers in real time, the author presents some data about the evolution of the fees paid by individuals over 23 Aplotofinflationratesinthe18countriesconsideredmakesthisquite clear. 24 Included, but outside the scope of this paper, are the important and still unresolved questions surrounding privacy and the use of private information for commercial or other reasons. See, for example, Siklos (2022a)andreferencestherein. 25 ForananalysisspecifictoCanadathatusesthesamedatareferredto below,seeDimbueneandTurcotte(2019).Notethattheauthorsonly examine funds sent from Canada to other countries and focus on the record in 2017. time. As usual, there are data limitations. That said, a reasonably clear picture begins to emerge. First, other than in the Philippines, the number of transactions completed using firms that transfer funds essentially in real time rose between 2016 and 2021. The increase is most noticeable for India and Jamaica. Equally impressive, however, is the reduction in the proportion of banks as intermediaries in these kinds of transactions. Next, average fees and the standard deviation across various intermediaries of all types, are shown for the 2016–2021 period for the same countries as before but with the global average added as a benchmark.26 The data source subdivides fees according to transactions of two sizes, namely, $200 and $500 per remittance transferred. First, consider small transactions. In all the countries shown, as well as at the global level, fees have declined. However, much of the decline is a one-time drop in fees. This takes place mainly in 2017 in three of the four countries considered, with Jamaica lagging behind but showing a substantial drop in fees by 2020. In contrast, fees for the relatively larger remittances (i.e., $500) have been more stable. Nevertheless, some actually increased slightly between 2016 and 2020, such as in the Philippines. Also notable is the relatively small standard deviation in remittance fees for the four countries shown, especially when compared to global values. Therefore, while one may wonder how much scope there is to reduce the fees for small and large transactions of the kind shown in Table 2, there seems to be much greater scope for doing so at the global level. This suggests that, globally, a retail CBDC can enhance market contestability in cross-border transfers, such as remittances. However, there still are additional unanswered questions from the data shown in Table 2. The data is not informative about the extent to which individuals simply shifted from making small to larger remittances to reduce transactions costs. The same issue would, presumably, arise with retail CBDC unless there is some agreed upon protocol by central banks and governments that cooperate in a cross-border scheme of some kind. Next, the developments in the four countries, which explain not only transactions costs but the resort to fast 26 According to the data source, data before 2016 may not be, strictly speaking, comparable. 11A Digital Loonie among Many Digital Currencies: Prospects and Outlook versus bank-based remittances, do not explain the extent to which domestic regulations, or even cellphone or internet accessibility, may have driven down fees over time. Finally, and relatedly, there are geopolitical considerations to think about that likely also impact not only the choice of currency in cross-border transactions but also the choice of intermediary to carry them out. Figures 2 to 4 provide a few more insights into the potential for retail CBDC to become a game changer in facilitating cross-border payments. Figure2 indicates that, as a percent of the size of the remittance, there is considerable cross-country heterogeneity with relative stability at the global level.27 Moreover, it is not the case that banks in the larger EMEs necessarily charge smaller fees; there is also considerable variation over time in remittance fees. Indeed, if the stability at the global level is thought to represent a minimum of sorts that cannot easily be breached, then we have some clear indications about an objective that retail CBDC can aim for if the promise of lower transactions costs is to be realized. 27 As noted above, however, the variance of global fees is considerably larger than for the individual countries shown. Table 2: Select Summary Statistics on Remittances Date Global China India Jamaica Philippines Banks (%) Fast (%) Banks (%) Fast (%) Banks (%) Fast (%) Banks (%) Fast (%) ND How remittances are made: institutions used 2016 Q2 50 37.5 47.4 31.6 28.6 23.5 23.8 52.4 2021 Q3 21.4 42.9 37.9 48.3 17.6 52.9 16.7 40 Date Global China India Jamaica Philippines Average fee in US dollars (standard deviation) in making remittances 2016 7 (5) 5 (3) 9 (0) 5.67 (0.58) 7.33 (0.58) 5.67 (2.08) 9.44 (0.58) 6 (1) 6 (0) 4 (0) 2017 7 (5) 5 (3) 6.75 (1.71) 3.75 (1.71) 6 (0) 4.50 (2.38) 9.75 (0.50) 6.75 (0.50) 4.75 (0.50) 2.50 (0.58) 2018 6.96 (5.07) 4.50 (3.34) 6 (0) 3.25 (0.50) 5.45 (0.53) 3.38 (0.48) 9.70 (0.87) 6.73 (0.91) 3.25 (0.50) 2.50 (0.58) 2019 6.83 (5.21) 4.47 (3.46) 6.93 (1.51) 5.38 (0.85) 5.50 (0.62) 4.53 (1.44) 9.63 (1.76) 7.23 (1.74) 5.38 (0.85) 2.82 (0.84) 2020 6.66 (5.40) 4.39 (3.46) 6.58 (0.97) 4.60 (0.57) 4.84 (0.26) 2.63 (0.15) 6.89 (0.94) 4.63 (0.87) 4.60 (0.57) 2.73 (0.35) 2021 6.31 (5.45) 4.20 (3.44) 6.77 (0.25) 4.70 (0.17) 5.06 (0.13) 3.10 (0.10) 6.93 (0.65) 5.23 (0.40) 4.43 (0.55) 2.67 (0.15) Source: As calculated by the author from data found at World Bank, Remittance Prices Worldwide, http://remittanceprices.worldbank.org. Notes: Data for 2016 begins with 2016 Q2; for 2021, the data ends with 2021 Q3. Banks = number of banks as a percent of all funds transfer providers; fast = number of providers offering funds transfers in less than an hour as a percent of all providers; global = fee based on data for all countries in the data set. ND means data was unavailable. 12 CIGI Papers No. 269 — October 2022 • Pierre L. Siklos Figure 2: The Size of Remittance Fees Remittance Fees as a Percent of $500 Transfer 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 2016 Global IND CHN PHL JAM 2017 2018 2019 2020 2021 CHN JAM PHL IND Global Q2 Q3 Q4 Q2Q1 Q3 Q4 Q2Q1 Q3 Q4 Q2Q1 Q3 Q4 Q2Q1 Q3 Q4 Q2Q1 Q3 Remittance Fees as a Percent of $200 Transfer 3% 4% 5% 6% 7% 8% 9% 10% 11 % 12 % 2016 2017 2018 2019 2020 20 21 CHN JAM PHL IND Global Q2 Q3 Q4 Q2Q1 Q3 Q4 Q2Q1 Q3 Q4 Q2Q1 Q3 Q4 Q2Q1 Q3 Q4 Q2Q1 Q3 Global IND CHN PHL JAM Source: http://remittanceprices.worldbank.org. Notes: CHN = China; IND = India; JAM = Jamaica; PHL = Philippines. 13A Digital Loonie among Many Digital Currencies: Prospects and Outlook Figure 3: Remittance Costs in Selected Recipient and Sender Countries Remittance Costs to EMEs 2 4 6 8 10 12 14 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 BRA CHN IDN IND MEX TUR ZAF CHN ZAF TUR IDN BRA MEX IND Remittance Costs from AEs 4 6 8 10 12 14 16 18 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 AUS CAN DEU FRA GBR ITA JPN KOR USA JPN CAN FRA GBR ITA DEU AUS KOR USA Source: http://remittanceprices.worldbank.org. Notes: Costs are a percent of the size of the transaction. AUS = Australia; BRA = Brazil; CAN = Canada; CHN = China; DEU = Germany; FRA = France; GBR = Great Britain; IDN = Indonesia; IND = India; ITA = Italy; JPN = Japan; KOR = Korea; MEX = Mexico; TUR = Turkey; USA = United States; ZAF = South Africa. 14 CIGI Papers No. 269 — October 2022 • Pierre L. Siklos Figure 3 examines large EMEs and AEs to assess the changes in remittance costs for sender countries, typically AE, and receiver, generally EME, countries over a longer period (2011–2020). Although there is a trend of sorts toward lower fees for both sender and receiver countries, and the spread in costs between the countries shown has declined, fees remain substantial. Finally, Figure 4 provides an indication of the digital evolution across many countries, based on a survey for the year 2019. Digital evolution consists of combining different characteristics related to the availability and development of digital technologies in different countries.28 Two features of the figure stand out. First, other than China, no EME is in the above-average group of countries. If central bank digital money facilitates improvements in cross-border transactions, this might be expected to generate some convergence between fees charged in AEs versus EMEs. Of course, this is critically dependent on international cooperation to prevent unnecessary impediments to the flow 28 Seethenotestothefigure.Essentially,themetricisanaggregation of factors that describe the environment, experience, attitudes and behaviour of digital technology users. Environment refers to accountability,privacyandsecurityconsiderations;experiencemeasures access, the state of digital infrastructure and interaction with digital technology;attitudesrefertotheusers’sentimenttowardandconfidence indigitaltechnology;andbehaviourseekstocapturetheintensitywith which users engage with the digital world. Figure4:DigitalEvolutionaroundtheWorldin2019 0 20 40 60 80 100 ARE AUS AZE BGD BHR BOL CAN CHL CIV COL CZE DNK ECU ESP ETH FRA GEO GRC HRV IDN IRL ISL ITA JPN KEN KOR LBN LTU MAR MYS NGA NOR PAK PHL PRT ROU RWA SGP SVK SWE TUN TWN UGA URY VNM USA SGP NLD CHE DNKFIN HKG IRL ISL NOR SWE TWN KOR AUS CANGBR JPN DEU CHN EST ISR Sources: Data constructed from Chakravorti et al. (2020, figure 11). Also see The Fletcher School at Tufts University, Digital Intelligence Index, https://digitalintelligence.fletcher.tufts.edu/trajectory. Notes: Horizontal dashed line represents the mean across all countries. ARE = United Arab Emirates; AUS = Australia; AZE = Azerbaijan; BGD = Bangladesh; BHR = Bahrain; BOL = Bolivia; CAN = Canada; CHE = Switzerland; CHL = Chile; CHN = China; CIV = Côte d’Ivoire; COL = Colombia; CZE = Czech Republic; DEU = Germany; DNK = Denmark; ECU = Ecuador; ESP = Spain; EST = Estonia; ETH = Ethiopia; FIN = Finland; FRA = France; GBR = Great Britain; GEO = Georgia; GRC = Greece; HKG = Hong Kong; HRV = Croatia; IDN = Indonesia; IRL = Ireland; ISL = Iceland; ISR = Israel; ITA = Italy; JPN = Japan; KEN = Kenya; KOR = Korea; LBN = Lebanon; LTU = Lithuania; MAR = Morocco; MYS = Malaysia; NGA = Nigeria; NLD = Netherlands; NOR = Norway; PAK = Pakistan; PHL = Philippines; PRT = Portugal; ROU = Romania; RWA = Rwanda; SGP = Singapore; SVK = Slovakia; SWE = Sweden; TUN = Tunisia; TWN = Taiwan; UGA = Uganda; URY = Uruguay; USA = United States; VNM = Vietnam. 15A Digital Loonie among Many Digital Currencies: Prospects and Outlook of retail funds between countries.29 This is an input into the quest for successfully introducing a retail CBDC, and the figure ought to make clear that both AEs and EMEs have an incentive to cooperate if this is the vehicle used to enhance cross-border payments. Second, as is true for the other elements essential for the widespread introduction of retail CBDC, the gap between the levels of digital evolution for the countries shown is quite wide. Regardless of what form a retail CBDC will take, this will hamper its rollout globally. So far, the author has explored areas where there is the potential for retail CBDC to make its impact felt. Alongside these opportunities are threats. Just as in the case of the determinants of currency holdings, the threats emerge from the political economy realm. Table 3 provides a selection of indicators associated with globalization. If globalization can facilitate crossborder relations, or at least reflect the reduction in barriers to enhance cooperative behaviour, this will reduce the difficulties encountered that might prevent the global use of retail CBDCs. Eight indicators of factors in the adoption of retail CBDC for the G20 are displayed in Table 3. While de jure indicators of central bank independence (CBI) have been criticized, they provide some indication of the extent to which the economies in question view the role of central banks that will be directly implicated in the rollout and management of retail CBDC. And since more central banks adopted inflation control strategies during the 1990s, combined with greater autonomy, the global rise in CBI reflects a common global development in the management of monetary policy. The range between highest and lowest on the 0–1 scale is fairly wide. Japan is lowest on the scale and the European Central Bank (i.e., France, Germany and Italy) is highest. Unless one believes that only the narrowest form of retail CBDC will ever be introduced, that is, as a pure complement to existing notes and coins, the digitalization of money does potentially raise, as pointed out above (also see Siklos 2022a), several issues that blur the distinction between monetary and fiscal policy. Once retail CBDCs are introduced, there will be a strong temptation to expand their role if conditions warrant (for 29 Unfortunately,wearealongwayfromrealizingthepotentialforreduced fees.Forexample,Beck,JanfilsandKpodar(2022)andtheCommittee onPaymentsandMarketInfrastructures(2020),whodiscussthe challenges with cross-border wholesale CBDC transactions, point out that the challenges are multiplied in the case of retail CBDC. example, a crisis). A solution is for central banks to ensure that a directive, or memorandum of understanding, between the political and monetary authorities is negotiated to ensure rules of the game, including privacy and property rights, to give two examples, concerning the type and scope of retail CBDC are clearly laid out. Trade openness is another factor that ought to influence the adoption of retail CBDC. As seen from Table 3, it is high, although it lags considerably in major economies (for example, Brazil, Japan, India and the United States), and this may reduce the urgency of policy makers to deal with global rules once retail CBDCs are deployed. Since an aim of digitalization is to facilitate cross-border flows at the retail level, thereby reducing transactions costs, it is not unreasonable to expect that it might spur some forms of foreign direct investment (FDI). Once again, the gap between the highest and lowest estimates is not trivial, and the substantial variation over the years, as proxied by the standard deviation of the estimates shown, is also considerable. Hence, it is not immediately apparent that FDI rates are informative about the scope for cooperative behaviour in the global spread of retail CBDC. FDI rates are, of course, also partially governed by regulations in place and the openness with which the recipient country welcomes foreign investment. It is, therefore, interesting that Japan scores lowest among the G20, since an apparent aim of a retail CBDC for that country is to improve cross-border payments. A complementary indicator is net portfolio investments. While there are substantial crosscountry differences, only five out of 19 countries, including Japan, are net sellers of equities and securities while the remaining countries generate net outflows. This further suggests additional cross-country financial interdependence, which should facilitate the global spread of retail CBDC as well as provide an incentive for policy makers to develop global rules for cross-border transactions for CBDC at both retail and wholesale levels. Next, the author considers the KOF’s de facto measure of informational globalization, which combines a country’s internet bandwidth capacity, the number of patents applied for and exports of high-level research and development products. This is presumed to provide some signal of a country’s ability to handle the substantial technical demands of a retail CBDC, including the ability to participate in a global network to facilitate 16 CIGI Papers No. 269 — October 2022 • Pierre L. Siklos Table3:FactorsintheAdoptionofrCBDC,1990–2019 Country CBI (2000–2017) FDI (2000– 2019) %GDP Open % GDP NPI Bill USD Informational Globalization (1990–2019) Age Dependency Ratio (1996– 2019) Rule of Law (2002– 2019) EPU (2000–2022) Debt-to-GDP Ratio (2012–2020) Argentina 0.67 2.00 (0.77) 28.2 -3.65 1.90 (2.71) 58.7 (2.7) -0.61 (0.18) ND 63.12 (22.93) Australia 0.36 3.45 (1.96) 40 -1.59 0.58 (1.21) 49.8 (1.8) 1.78 (0.06) 105.86 (59.39) 39.66 (8.90) Brazil 0.35 3.27 (0.91) 23.2 -1.31 1.93 (2.65) 49.1 (5.0) 1.78 (0.06) 105.56 (91.75) 76.83 (13.47) Canada 0.54 3.25 (0.91) 66.6 -2.25 0.70 (2.65) 46.2 (1.8) -0.20 (0.14) 179.82 (116.27) 91.33 (10.07) China 0.67 3.25 (2.21) 42.4 -1.30 5.17 (6.11) 40.7 (4.3) -0.44 (0.12) 195.14 (167.48) 47.79 (10.48) France 0.91 2.12 (1.05) 53.1 -1.92 1.32 (2.49) 55.8 (2.9) 1.43 (0.06) 189.65 (102.08) 97.93 (6.92) Germany 0.91 2.54 (2.61) 67.1 3.85 0.93 (7.94) 50.5 (2.5) 1.66 (0.07) 155.53 (89.95) 70.24 (7.52) India 0.45 1.62 (0.72) 35.3 -8.93 2.99 (5.75) 58.1 (5.9) 0.02 (0.08) 91.50 (46.88) 78.62 (7.05) Indonesia 0.84 1.27 (1.51) 54.1 -6.29 2.99 (5.74) 52.2 (3.3) -0.58 (0.19) ND 28.27 (4.11) Italy 0.91 1.22 (0.84) 49 6.76 1.81 (4.35) 51.9 (5.9) 0.46 (0.13) 112.71 (41.36) 135.92 (7.95) Japan 0.32 0.28 (0.24) 25.2 3.58 1.75 (3.58) 54.5 (7.9) 1.38 (0.13) 107.31 (32.78) 233.74 (8.15) Korea 0.62 0.96 (0.39) 70.8 -5.52 1.58 (2.39) 37.8 (1.2) 1.01 (0.11) 141.39 (68.43) 40.50 (3.47) Mexico 0.57 2.80 (0.63) 54.9 -1.18 2.18 (3.29) 58.4 (5.9) -0.50 (0.11) 83.46 (61.28) 52.10 (5.56) Russia 0.48 2.21 (1.18) 54 3.58 1.68 (5.01) 43.3 (3.5) -0.83 (0.08) 162.61 (125.87) 14.42 (2.26) Saudi Arabia 0.50 2.22 (2.80) 73.1 5.44 3.38 (6.13) 54.9 (13.0) 0.10 (0.08) ND 13.01 (10.78) South Africa 0.46 1.42 (1.22) 53.6 -5.27 2.36 (3.50) 56.5 (5.6) 0.10 (0.09) ND 48.10 (9.60) Turkey 0.83 1.59 (0.85) 47 -5.11 2.23 (8.23) 53.9 (3.7) -0.01 (0.16) ND 30.90 (3.87) United Kingdom 0.35 4.36 (3.53) 54.1 -8.18 1.39 (4.76) 54.5 (1.7) 1.71 (0.08) 210.73 (154.27) 87.83 (6.43) United States 0.63 1.79 (0.65) 25.1 -2.66 0.50 (1.51) 51.0 (1.2) 1.58 (0.06) 137.18 (66.12) 108.80 (9.57) Sources: Central bank independence is from Romelli (2022); FDI to % GDP, age dependency ratio, rule of law and debt-to-GDP ratio are from the World Bank Development Indicators (https://databank.worldbank.org/source/world-development-indicators); informational globalization is from KOF (https:// kof.ethz.ch/en/forecasts-and-indicators/indicators/kof-globalisation-index.html); EPU is from www.policyuncertainty.com/. All data is annual. Notes: Standard deviation over the period covered in parentheses. FDI = foreign direct investment; NPI = net portfolio investments; EPU = economic policy uncertainty; ND = no data; USD = US dollar. 17A Digital Loonie among Many Digital Currencies: Prospects and Outlook cross-border transactions. Both the gap, and the variability over time, between the most and least informationally globalized country is large (the range is 0.50–5.17). Over the 1996–2019 period, China was far ahead of any other G20 economy. The potential role of an aging population has already been noted, but differences in mean values shown for the 1996–2019 period are also substantial. Canada is in the middle of the group at 46.2 years. To the extent that these differences translate into differences in priorities over the speed and nature of the progress of the digitalization of currencies, the age dependency ratio may provide clues about which groups of countries are likely to be part of the first wave of those introducing a retail CBDC. If there is a firstmover advantage, this can impact the international usage and access of some digital currencies. Property rights were seen earlier to have an impact on the desirability of holding cash. A related indicator is the World Bank’s rule of law index, with negative values indicating a deterioration in this proxy, while positive values signal improvements in this metric. On this score, 12 of the G20 countries display positive values even though there are noticeable gaps in the score. That said, since a critical element of any retail CBDC is the legal environment in which it exists, the record over the 2002–2019 period not only suggests that common legal ground can be found, but also which countries are likely to be able to create the required coalition to facilitate crossborder digital money transactions. Unfortunately, Canada is the only AE where the rule of law has deteriorated over the period considered. Finally, a country’s views about the net benefits of a retail CBDC from a global perspective may well be influenced by how much economic policy uncertainty (EPU) is present. Sadly, three out of the five countries where EPU is highest, including Canada (fourth), are AEs. EPU may limit the speed with which a retail CBDC is introduced, persuade policy makers to narrow its access for cross-border transactions and limit the ability of policy makers across the G20 to agree on common standards.30 30 WhileTable3providesaveragescoresoverthe2000–2022period, Siklos(2022a)alsoreportsthatthetrendsinEPUhavebeenlargely positive over the past decade. This adds to the challenges of deploying retail CBDCs as a means of facilitating cross-border transactions. Currency Substitutability: AThreattotheLoonie? Alberto Giovannini and Bart Turtelboom (1992) provide the last notable survey about currency substitution (also see Calvo and Végh Gramont 1992; Cohen 1998). Only a handful of empirical studies have been published in recent years using data from currencies in small developing or emerging countries. Critically, the relevant empirical studies often omit an explicit role for institutional considerations, even if this is clearly essential in evaluating the desirability of holding any currency. We have already seen that institutional considerations loom large, not only in explaining currency holdings but also in the prospects for retail CBDCs to have a meaningful global impact. Indeed, the last time a substantive public debate was held about the role and value of the Canadian dollar was during the 1990s when even its existence was put into question (also see footnote 9 above). While it is outside the scope of the present study to explore the potential for substitution away from the Canadian dollar in the presence of some, as yet non-existent, retail CBDC and the absence of global rules and regulations governing access and usage beyond borders, it is possible to comment on the potential for dollar digitalization to enhance its place among the most globally important currencies. Keeping in mind that the distinction between wholesale and retail is not always clear from the available data, Figure 5 shows, for a selection of G20 economies, the relative importance of foreign currency liabilities, as a percent of GDP, at banks. These are, by far, denominated in US dollars.31 By the mid-2000s, Canada was a close third behind Britain and Japan. The share of foreign currency liabilities has risen substantially; over time, the same trend is much less apparent in the other countries shown, except France. While the close trading relationship between the United States and Canada is an obvious reason for the size and the changes over time in foreign currency liabilities, it cannot be the entire story. The rise, no doubt, also reflects the relative importance of the US dollar in price setting, for example, for commodities. However, what is equally notable is 31 More details are available from BIS, Consolidated banking statistics, www.bis.org/statistics/consstats.htm?m=2070. 18 CIGI Papers No. 269 — October 2022 • Pierre L. Siklos that, except possibly for the British pound, there is a negative relationship between changes in the shares for Canada, Japan and the euro area, and changes in the nominal exchange rate.32 Therefore, it is not unreasonable to expect that, if retail CBDCs are introduced by large AEs in the near future, and the regulatory roadblocks previously discussed preventing ease of use for cross-border transactions can be avoided, how foreign exchange markets view the Canadian dollar will be critical in the long-term success of a digital loonie. Assuming these markets are influenced by the quality of macroeconomic management, there is no reason to expect the Canadian dollar’s role in digital money to be threatened. Of course, as others will point out, the success of any digital loonie will need to be backed up by the ability of the authorities to provide holders with confidence and, therefore, trust in the digital technology being employed. Here the evidence is less clear. One survey 32 Thecorrelations(withsignificanceorp-valuesgiveninparentheses) are:GBR0.12(0.10),JPN-0.65(0.00),CAN-0.14(0.06)andEUR -0.57(0.00).TheestimateforGBRisbarelystatisticallysignificantat conventionalsignificancelevels. (Chakravorti et al. 2020) ranks Canada well below the international average of 42 countries surveyed.33 Conclusions and Policy Implications Interest in digital currencies parallels growing interest in digitalization more generally. Central banks have long stressed, at the retail level, that a retail CBDC is intended to complement and not replace existing notes and coins in circulation. Of course, this has not prevented observers from predicting the end of paper money and coins, although this seems highly unlikely in the short to medium term. Simple examination of the large 33 A bar chart with the results of the survey is available in the Appendix. The collectionofdataisavailablefromTheFletcherSchoolatTuftsUniversity, DigitalIntelligenceIndex,https://digitalintelligence.fletcher.tufts.edu/ trajectory. Figure5:Banks’ForeignCurrencyLiabilitiesinUSDollars 0 400,000 800,000 1,200,000 1,600,000 2,000,000 2,400,000 0 200,000 400,000 600,000 800,000 1,000,000 1,200,000 198019851990199520002005201020152020 AUS BRA CAN DEU FRA GBR IDN IND ITA JPN KOR MEX RUS SAU TUR ZAF CAN GBR JPN Millions USD Millions USD Source: BIS, Consolidated banking statistics, www.bis.org/statistics/consstats.htm?m=2070; author’s calculations. Notes: AUS = Australia; BRA = Brazil; CAN = Canada; DEU = Germany; FRA = France; GBR = Great Britain; IDN = Indonesia; IND = India; ITA = Italy; JPN = Japan; KOR = Korea; MEX = Mexico; RUS = Russia; SAU = Saudi Arabia; TUR = Turkey.