The Future of Central Banking (2024)

1.1 Money – chains of trust –

Money, as well as “fire” and “language”, is undoubtedly one of the greatest inventions of humanity. In the course of its history, various materials have been used; the first metal money was cast in Lydia around three thousand years ago.^[2]

Money enables human beings to exchange goods and services across space and over time, and facilitates economic transactions.^[3] Regardless of its material, the mainspring of money has always been “trust” and “credit”. Money can perform its function as a medium of exchange as long as each user has reasons to believe that others will also continue to accept it. In so far as they were able to create such “chains of trust” with unknown others, human beings developed an economic society that set them apart from other species.

1.2 Banks – gathering and processing information and data –

Banks were created in the Renaissance era in Italy around six hundred years ago.^[4] The development of commercial banks coincided with those of two great technological innovations during or immediately before that period. One of them was movable type printing – a technology introduced by Johannes Gutenberg. The other one – double-entry accounting – was introduced before the birth of commercial banks.^[5] The Medici family, who operated the first modern-style commercial bank (the Medici bank), made use of double-entry bookkeeping and developed various businesses, including banking.^[6]

Since banking services consist in processing information and data, the development of commercial banking has obviously been closely linked to the development of information technologies.^[7] In the course of their history, banks have adopted various new technologies, such as the electrical telegraph and computers, which they have used to extend their operations, including correspondent banking and electronic fund transfers. Processing information and data has always been at the heart of banking activities. For example, opening deposit accounts allows banks to gather information and data, which they can then utilize for risk assessment and to make loans.

1.3 Central banking – a “trust machine” meant to enhance the efficiency of the economy –

Central banks, many of which were created at the final stage of the establishment of nation states, are a modern-age invention. As illustrated by most relevant papers, such as Amamiya (2018), Maes (2018) and Shizume (2017), the history of modern central banking is less than two centuries old, which is far shorter than the history of money or commercial banks. Indeed, the U.S. Federal Reserve was created in 1913, and the Bank of Japan was established in 1882. A few central banks, such as the Riksbank in Sweden and the Bank of England in the U.K, have a longer history than others.^[8] Nonetheless, these banks were created as entities that were akin to commercial banks or clearing houses, and then transformed into modern central banks in the nineteenth century. For example, the Bank of England was given exclusive note-issuing powers by the Bank Charter Act of 1844, and the Riksbank was given a monopoly on issuing banknotes in 1897.^[9]

The invention of central banking as the sole issuer of currencies has greatly contributed to the efficiency of payments and economic transactions, and thereby to economic growth. If two or more currency units were used in a single jurisdiction, individuals and firms would need to verify the credibility of each of these currency units and decide whether they can accept it or not at each transaction. Moreover, they would have to bear the cost of the exchange rates for each currency units at each transaction. In this regard, the invention of modern central banking has significantly reduced the costs and risks in the economy. Over the past century, almost all nation states, including developed, emerging and developing nations, have given their own central banks the exclusive responsibility of issuing sovereign currencies,^[10] which has led to the current two-tiered monetary system, consisting of the central bank and commercial banks – a system that has proved effective and efficient in enhancing the efficiency of transactions and the development of the economy.^[11]

Needless to say, if a central bank, the sole issuer of a nation’s sovereign currency, loses its discipline and public trust, it may trigger hyperinflation and substantially damage the economy. There has been much concern among experts over central banks’ monopoly on issuing sovereign currencies, and some scholars such as Friedrich von Hayek advocated full competition between currencies.^[12] Nonetheless, such proposals have not been implemented in the real world yet because the current system has proved to be efficient. At the same time, in so far as the monopoly central banks have on issuing sovereign currencies comes with risks, the trust and credibility of central banks must be backed up by robust institutional frameworks, such as legal, administrative and tax systems. That is the main reason why modern central banks were born after the establishment of modern nation states that were able to establish resilient institutional frameworks, including legal and taxation systems. For example, the establishment of the Bank of France (in 1800) coincided with that of the Civil Code in France, and the Bank of Japan was created soon after the Meiji Restoration.

In the two-tiered monetary system, private entities such as commercial banks compete with each other for providing innovative payment instruments such as bank deposits, checks, credit cards and mobile payments, while using common currency units such as the dollar and the yen. In this regard, the two-tier monetary system also strikes a balance between payment stability and private-led innovation.

1.4 Modern central banking: An established model

In the course of their brief history, central banks have established a broadly-shared style. Central banks issue paper banknotes to the general public for daily payments. Accordingly, people can use risk-free central bank money on a 24/7 basis. In addition, most central banks operate large-value settlement systems such as real-time gross settlement (RTGS) systems, and allow commercial banks to maintain transaction accounts with them. Interbank settlements rely heavily on these systems which make it possible to settle large-value transactions with risk-free central bank money on a digital basis. However, they function under the time constraint of their operating days and hours since many of them are not operated on a 24/7 basis.

As each nation’s central bank is the sole issuer of the nation’s sovereign currency, it is able to provide liquidity without limit, at least theoretically. In other words, the central bank in each nation can issue and provide its own liabilities, namely, central bank money, in exchange for various kinds of assets.

By virtue of its powers the central bank engages in various activities, including monetary policy and market operations. (For example, in purchasing operations the central bank provides its own liabilities in exchange for securities and imposes downward pressure on market interest rates.) Among the activities carried out by the central bank, that of “lender of last resort (LLR)” has been one of its major functions almost since its very beginning, partly because many central banks, such as the Bank of Japan and the Federal Reserve, were created to stabilize the financial system.^[13]

The LLR function also stems from the central bank’s power to create its own liabilities. By providing central bank money in exchange for assets held by a bank facing a liquidity problem, the central bank can fill the liquidity gap in order to maintain stability. (If the central bank is unable to mitigate liquidity problems, the liquidity shortage of a specific bank might have spillover effects and destabilize the financial system as a whole.)

In most cases, financial institutions having direct access to central bank accounts are eligible to central bank credits on condition that they are under central banks’ supervision or oversight. In this respect, their power to create liquidity has also entitled central banks to supervise financial institutions.^[14]

Furthermore, since the Great Depression of the 1930s, growing attention has been paid to the role of central banks in terms of macro-policy, namely, monetary policy. Over a relatively short period of less than a century, various kinds of intermediary targets for monetary policy, such as money supply targeting and inflation targeting, were set, and new policy tools, such as forward guidance and negative-rate on central bank deposits under the zero-bound on nominal interest rates, were implemented in addition to authentic policy tools such as central bank loans and advances, the discounting of commercial bills and the purchasing and selling of securities. While adopting a stable model for payment and settlement infrastructures, central banks frequently changed their styles of monetary policy conducts, each of which was relatively short-lived.

(Evolution of recent styles of monetary policy)
	Before 1970s	1970s-	Around 1990-	Around 2000-	After 2000-	After GFC
Operational Tools	Discounting bills, Central bank loans Purchasing and selling securities (Open Market Operations) Reserve requirement			Forward Guidance on interest rates		Negative Interest rates
Policy Targets (Primary, Inter -mediary	Interest rates	Monetary aggregate (Money supply) Targeting	Inflation targeting		Quantitative easing (Targeting base money and/or other quantitative indicators)

Although the ultimate goal of monetary policy has been “price stability” for most central banks, monetary policy strategies have frequently changed, reflecting economic and financial environments as well as deregulation and globalization. For example, in order to deal with “creeping inflation”, the concept of “money supply targeting” was introduced in the 1970s. Nonetheless, due to deregulation and globalization, monetary aggregates were destabilized in many countries, which made it impossible to use them as intermediary targets.^[15] Since around 2000, due to the global disinflationary trend, some central banks in developed economies have hit the “zero-lower bound (ZLB)” on nominal interest rates.^[16] In order to overcome the ZLB and cope with the effects of the global financial crisis of 2007–08, several central banks have introduced new operational tools and policy targets, such as negative interest rates on central bank deposits and quantitative easing (QE).^[17]

2.1 The intensification of the globalization of the economy

Economies have been increasingly interconnected: Many firms are now operating across borders, and the number of tourists continues to grow, in part on account of the growth of income in emerging and developing economies. In addition, giant firms providing global platforms for e-commerce and other businesses have emerged.

In such an environment, cross-border transactions are increasing, and firms as well as individuals are becoming more aware of both explicit and implicit costs for them. These costs may include fees for cross-border fund transfers through correspondent banking, fees relating to international credit cards, and various costs stemming from currency exchanges as well as the handling of physical cash. (For example, if tourists need to withdraw cash in their native countries, carry it with them and then exchange it for foreign currencies, they have to bear the exchange fees, that is, the implicit costs of carrying cash and exchange rate risks.) Several non-bank firms are now entering into cross-border payment businesses and offer less costly services.

As most countries came to have their own central bank in the last century, the number of central banks gradually increased and became almost equal to the number of nations. Later on, however, there has been a growing trend towards currency union, and by the end of the last century, the European Central Bank (ECB) was established. The ECB, as well as several other initiatives in Africa and the Caribbean states, could be regarded as part of a wider effort to reduce the cost of cross-border transactions through the sharing of a central bank and of a common currency unit.^[18] Although central banks are still needed, having one’s own central bank may no longer be a necessary condition to remain a nation state. Nations are increasingly capable of sharing a central bank, provided they join forces to create a robust and effective framework that guarantees its trustworthiness and credibility through the harmonization of diverse economic policies and infrastructures.

Besides, the cost of using foreign currencies seems to gradually decline due to the globalization of corporate activities and to digital innovations.^[19] Accordingly, each currency is now facing tougher competition from foreign currencies, and central banks are required to make more efforts towards enhancing the efficiency and utility of their own payment and settlement infrastructures in order to help financial markets and companies to remain competitive. Recently, several central banks started to operate their real-time gross settlement (RTGS) systems on a 24/7 basis in order to support private-based payments – an initiative worth considering in the present context.^[20]

2.2 Innovation in information technologies, data revolution and “FinTech”

Since the beginning of the twenty-first century, innovation in information technologies has further accelerated. In particular, during the period of the global financial crisis (GFC) several epoch-making technologies were born almost simultaneously, and have fostered the development of “FinTech”.

First, the iPhone was introduced in 2007, and within just a decade smartphones were rapidly popularized globally. According to the World Bank Group (2017), out of 1.7 billion unbanked adults, 1.1 billion people already have a mobile phone. Smartphones are now widely used as instruments for “mobile” payments, and for promoting financial inclusion, especially in emerging and developing economies.

Second, crypto-assets and their underlying technologies, namely blockchain and distributed ledger technology (DLT), were introduced in 2009. Although crypto-assets are not widely used as daily payment instruments, blockchain and DLT are expected by some to have the potential to be applied to a wide range of financial businesses, for recording transactions and ownership rights for various assets without having a centralized ledger-keeper. They could also be applied to central banking in the future.

Third, Artificial Intelligence (AI) has been developing rapidly. In particular, machine learning (ML) and deep learning (DL) have been making great progress over the last decade. AI is now being used by a variety of businesses, including financial services as well as for trading and investment strategies on financial markets.

Crucially, a global “data revolution” is under way. Billions of smartphone users worldwide are producing gigantic amounts of data through SNS posting, web-browsing and playing games. It is estimated that over 90 % of the data produced in the history of humanity have been created in the last two years alone (SINTEF, 2013). Data are now regarded as the “oil of the twenty-first century”: as useful intangible assets, they can create added-value in multiple ways.

Backed up by these technological advances and by the data revolution, a new industrial movement has emerged: “FinTech”, that is, the application of new information technologies such as smartphones, AI, blockchain and DLT to financial services. Many new entities, including IT companies, start-ups and BigTech firms are now entering into financial businesses.

FinTech has the potential to push back the frontiers of financial services, enhance the efficiency of financial services and increase people’s welfare. FinTech may also promote financial inclusion and “globalize” financial services, since more and more people in emerging and developing countries now have access to financial services through their smartphones. FinTech can also “personalize” financial services, since financial service providers are now able to customize their services thanks to AI and big-data, and provide services via smartphones, which are inherently very personal devices. Also, FinTech can “virtualize” financial services in so far as various entities can now offer financial services through smartphones, AI and cloud computing, making brick-and-mortar bank locations, ATMs and mainframe computers no longer necessary.

At the same time, digital innovation and FinTech are posing various new challenges to central banks.

First, due to digital innovation, firms and individuals are becoming more sensitive to the cost of handling, carrying and storing physical cash. In such a kind of environment, central banks may need to assess the efficiency of existing infrastructures such as physical cash as “operator”, and to consider whether there are any options to enhance the efficiency of the economy through improving their own services. Indeed, in major economies, besides trying to improve their real-time gross settlement (RTGS) systems, some central banks are studying the issues of a central bank digital currency (CBDC).

Second, as the number of entrants in the financial industry increases, central banks need to consider which entities should be allowed to have access to central bank accounts and liquidity provision. Moreover, in order to ensure the stability of payments, settlements and financial systems, central banks need to monitor or oversee not only the activities of traditional financial institutions but also those of entrants in the financial services industry. For example, since April 2018 the Bank of England has allowed non-bank payment services providers to directly access its settlement systems, on condition that they are under an effective supervisory framework.^[21] Furthermore, central banks are required to examine the impact of applying AI and algorithms to trading strategies such as high-frequency trading (HFT) on financial markets.

Third, as “catalysts”, central banks may need to consider how they can effectively communicate with a variety of entities to facilitate their coordination and cooperation with a view to enhancing the efficiency of financial services while maintaining financial stability.

2.3 Crypto-assets

With blockchains and the distributed ledger technology (DLT) of the Bitcoin, the first crypto-asset was born in 2009, and since then, thousands of crypto-assets have been issued. Crypto-assets are neither the liabilities of any specific issuers nor denominated by sovereign currency units. Although crypto-assets, which remain speculative investment tools, have not been widely used for daily payments so far, some argue that they might challenge sovereign currencies and central banks in the future.^[22]

2.4 “Cash-less” digital payments

Within the framework of a “two-tiered” monetary system, a nation’s central bank provides central bank money (base money), which consists of banknotes and central bank deposits, and private entities, such as commercial banks, supply private-based payment instruments such as bank deposits. As payment service providers, commercial banks and private firms have been competing with each other to provide innovative payment instruments, including checks, credit cards, debit cards and e-money.

Recently, in parallel with the rapid popularization of smartphones, digital and mobile payments such as Paypal, Alipay, WeChatPay, Swish and M-Pesa are being rapidly popularized and are now widely used for daily payments in many countries. With more widespread use of digital-based payment tools, firms and households are becoming more aware of the costs relating to the handling of physical cash.

Moreover, as data are becoming important assets in many businesses, various firms such as e-commerce and SNS companies are becoming interested in providing mobile payment services since they see payment networks as useful platforms for collecting customer data. In so far as they can utilize customer data obtained through payment services for a variety of transactions, businesses often provide these services without imposing any fees. From the customers’ perspective, using mobile payment services means giving away their own data instead of paying a fee. Consequently, money and data are increasingly interlinked, and individuals are now giving away their own data to private firms in exchange for discounts and rewards.

The development of digital-based “cash-less” payments also raises various issues that central banks should take into account. For example, mobile payments may pose new challenges regarding payment stability and cyber security. Data security and privacy are becoming all the more important as firms are accumulating huge amounts of customer data through digital payment platforms. In addition, since money and data are increasingly interlinked, central banks may need to consider the ways in which they can keep track of the evolution of economic activities and of relevant prices. For example, as many firms are offering discounts and rewards in exchange for virtually “purchasing” customer data, it is becoming difficult for central banks to keep track of the evolution of prices in e-commerce.

2.5 Central bank digital currency

Digital innovation has sparked growing interest in the possibility of a central bank digital currency (CBDC).

Some academics argue that central banks should issue their own digital currencies by applying advanced information technologies to their liabilities in order to enhance the efficiency and stability of payments and economic transactions. Although many central banks, including the Bank of Japan, announced that they did not have any immediate plan to issue digital currencies, several central banks are seriously considering whether they should issue their own digital currencies in the near future. For example, the Sveriges Riksbank in Sweden is conducting extensive studies on the feasibility of issuing its central bank digital currency, namely, the “e-krona”. The Riksbank already produced two reports in 2017 and 2018, respectively.^[23] The central bank of Uruguay experimentally issued the “e-peso”, its central bank digital currency, from November 2017 to April 2018.^[24] In January 2016, the People’s Bank of China also disclosed its plan to issue its central bank digital currency.^[25]

3.1 Crypto-assets will not threaten credible central banks

Crypto-assets, which have been issued so far, mainly remain speculative investment tools; they are not widely used as payment instruments for daily transactions, which shows that money and payment instruments rely on trust.

Crypto-assets inherently have several defects as payment instruments. Their price volatility is too high to be used for payments. Moreover, the fact that crypto-assets may need to establish their reliability from scratch may entail substantial costs, in terms of electricity consumption, in relation to “mining” in particular. On the other hand, central banks can issue sovereign currencies simply by increasing their liabilities. Since central banks can use their own trust and credibility, which have been established within the framework of modern nation states, the marginal costs for issuing sovereign currencies are close to zero. Accordingly, it is difficult for crypto-assets to compete with sovereign currencies issued by credible central banks. Creating trust is costly, and if people already have a credible central bank, it would be much less costly to use its existing trust for payment instruments, rather than trying to create trust from scratch.

Needless to say, if a central bank loses its trust and credibility due to inflation or a financial crisis, the existing advantages of its sovereign currency over crypto-assets will be lost in the process. Nevertheless, in this case, people are more likely to turn to credible foreign currencies than to crypto-assets. Therefore, it is unlikely that crypto-assets will threaten sovereign currencies issued by credible central banks. As long as central banks maintain public trust and credibility and achieve low inflation, it will be difficult for crypto-assets to challenge them.

In this respect, “Libra”, which is planned by Facebook’s affiliate, has interesting characteristics as a “stable” coin: It is planned to be backed up fully by safe assets denominated by credible sovereign currencies. In other words, “Libra” tries to make use of the trust of key currencies in order to stabilize its value. In this regard, Libra could be regarded as a combination of crypto-assets and sovereign currencies, and might have the potential to overcome several currencies lacking sufficient credibility.^[26]

At the same time, the technologies behind crypto-assets such as blockchains and DLT may have great potential for central banks themselves. For example, if these technologies are successfully combined with the existing trust and credibility of central banks, they could contribute to enhancing the efficiency of payments, settlements and the economy. Indeed, many central banks have engaged in research and experiments on these technologies. For example, the European Central Bank and the Bank of Japan have engaged in the joint DLT-related research entitled “Project Stella”. In phase one of Project Stella, blockchain and DLT were applied to interbank payment environments, where these technologies successfully realized liquidity savings mechanisms consisting of “queuing” payment instructions and executing bilateral netting. In phase two of the Project these technologies were applied to securities settlements and successfully implemented delivery-versus-payment (DvP).^[27]

3.2 CBDC issues will be further examined by many central banks

There is growing interest in the possibility of issuing central bank digital currencies (CBDC). In addition to its potential to enhance the efficiency of payments, settlements and economic transactions, experts are also focusing on the possibility of its contributing to strengthening the transmission mechanism of monetary policy and maintaining financial stability. Indeed, several central banks are studying various issues regarding CBDC.

For example, some scholars argue that CBDC may contribute to financial stability. Deposit insurance and central banks’ LLR functions are needed in relation to commercial banks’ maturity transformation. In this regard, they argue that CBDC could make deposit insurance and central banks’ LLR unnecessary. Such argument is similar to the idea of “narrow banking” proposed by Professor James Tobin in the 1980s (Tobin (1987)) for example, in the sense that it aims to limit commercial banks’ credit creation and maturity transformation.

Nonetheless, many issues need to be further examined in this respect. If CBDC substantially replaces not only banknotes but also bank deposits, it will squeeze credit intermediation through banks and inflate the central bank’s balance sheet instead. Central banks are neither destined to make loans directly to firms or individuals, nor suitable for evaluating the risks and returns of various projects. Accordingly, CBDC’s replacement for deposits may entail a distortion of the allocation of resources within the economy. Although banks could pay interests on their deposits to maintain their attractiveness over CBDC, it may not be easy for banks to offer sufficiently high interest rates on demand deposits, especially in low interest rate environments.

Moreover, stressful circ*mstances could trigger “digital bank runs”, in which depositors shift their deposits to CBDC through the Internet or smartphones. A digital bank run could be much faster than a traditional bank run, in which depositors have to be physically present at the bank or ATM to withdraw cash. Moreover, it could even occur during a weekend or in the middle of the night. Accordingly, in a stressful situation, a digital bank run could accelerate the spillover of liquidity problems across borders.

A digital bank run could occur even in the absence of CBDC since depositors would be able to transfer their deposits to other banks through the Internet. In addition, if the central bank could provide the banking sector with liquidity obtained through the shift of deposits to CBDC, it could compensate the shortage of liquidity at least on a macro basis. Nonetheless, in the real world, it might not be easy for the central bank or financial markets to cover up the source of liquidity crisis within a very limited timeframe. As such, many issues need to be further examined from the perspective of financial stability.^[28]

Some scholars also argue that CBDC may strengthen monetary policy transmission mechanisms in so far as the interest rates on CBDC might constitute a hard “floor” for a wide range of interest rates. There are also arguments that CBDC may contribute to overcoming the “zero-lower bound” on nominal interest rates, since it could easily set negative interest rates simply by reducing their nominal value.

Nonetheless, as long as paper-based banknotes continue to exist, the zero-lower bound will remain, even though CBDC is issued. It will be extremely difficult for central banks to completely abolish cash, since cash has its own benefits such as not relying on any electricity supply. Indeed, cash proved to be an effective payment tool even in the large-scale blackout caused by the earthquake in Hokkaido, Japan, in 2018. In addition, in so far as individuals can still use cash for various payments, without having to use a PC, a mobile phone or a smartphone, cash remains a convenient tool, especially for elderly people and in low-interest-rate environments, in particular in developed countries.^[29]

The argument that CBDC may enhance the effectiveness of monetary policy rests on the assumption that CBDC bears interest. However, an interest-bearing CBDC would squeeze bank deposits. On the other hand, if the interest rate on CBDC remained null, CBDC would even reinforce the zero-lower bound. As such, the possible impacts of CBDC on monetary policy should also be examined carefully, and it will take many central banks much effort to understand them in a comprehensive manner.

Some central banks have started operating their RTGS systems on a 24/7 basis to support private-based digital payments. They aim at reducing risks while maintaining private initiatives to promote innovation. In such an environment, central banks may need to examine whether the issuance of CBDC could have advantages over the “indirect” support based on the current two-tiered monetary system. In addition, since there is room for promoting the efficiency of payments even within the current two-tier system, central banks in the countries that are not facing a substantial decline in cash may have time to carefully consider whether CBDC will be definitely needed. Needless to say, the situation is likely to be more urgent in countries where the amount of cash is rapidly declining. Indeed, central banks in Sweden and China, where cash usage is declining, announced their plan to issue CBDC.^[30]

3.3 Central bank money will be required to support a wider range of payments

From the viewpoint of risk reduction, many entities including non-bank payment service providers are expressing their needs to access central bank money. Indeed, this is one of the reasons why CBDC is now gathering great attention.

The issuance of CBDC to the general public is similar to the case in which central banks allow ordinary people to access their accounts and operate their settlement systems on a 24/7 basis. In this regard, if central banks include a larger range of direct participants in their settlement systems and extend their operating hours, they might reap some of the potential benefits of CBDC while avoiding its risks as well as undesirable effects.

If direct access to central bank accounts is limited only to banks, it might be difficult for money market interest rates to converge, because non-banks will then have to invest in safe assets such as treasury bills, instead of central bank deposits. Since the prices of those safe assets may involve a “scarcity premium”, the interest rate on them would be lower than on central bank deposits.^[31] The problem is even more obvious if a central bank with abundant excess reserves wants to raise interest rates. In this regard, widening the range of entities having direct access to central bank deposits would strengthen the “hard floor” effect of central bank deposit rates.

With increased needs in terms of risk-mangement for digital-based payments, central bank money will be expected to facilitate a wider range of payments and settlements. Over the medium to long-term horizon, access to central bank RTGS systems is expected to be broadened and their operating hours extended. Indeed, several systems such as TIPS, launched by the European Central Bank, and FPP, by the Reserve Bank of Australia, started to operate on a 24/7 basis in order to support private based digital payments in 2018. The Bank of England allows several non-bank payment service providers direct access to its settlement system. This suggests that the extension of access to central bank infrastructures and of their operating hours are already under way.

3.4 Monetary policy and the LLR function will remain effective

In the near future, digital payment instruments denominated in sovereign currency units are expected to continue expanding.

As any payment instrument, including cash, has strong “network externalities,” it is difficult to determine how long it will take for digital payment tools to outstrip cash, since it may depend largely on country-specific conditions. For example, in countries where cash is widely used, it would take time for digital payment tools to replace cash due to its strong network externalities. Moreover, especially in countries with low interest rates, the demand for cash would remain strong, mainly for the purpose of storing value. Nonetheless, the digitization of payments will continue, and the use of digital-based “cash-less” payments and mobile payments will be further popularized across countries, due to the following two reasons:

First, as digital innovation fosters the development of various digital-based activities such as e-commerce, firms and individuals are becoming more aware of the costs of handling, storing and conveying physical cash. Although consumers do not directly bear the costs of handling cash, handling, storing and conveying cash is often costly, especially for firms and financial institutions.^[32] In this regard, digital payment instruments are needed since they are expected to reduce the costs of handling cash, enhance the efficiency of economic transactions, and promote the development of new businesses.

Second, being considered by some as the “oil of the twenty-first century,” data are intangible assets whose importance is growing while digital payment instruments that make it possible to record and convey a variety of data are now gathering great attention as tools to collect data. In this regard, the data revolution itself is the driving force for promoting digital-based “cash-less” payments. Cash can only convey data concerning the value. On the other hand, digital payment instruments can handle a variety of data, like “who buys what, when and where”. Many firms are now providing digital-based payment services in order to collect customer data by giving incentives and discounts to customers using digital-based payment instruments instead of cash.

Even if digital-based payment instruments become more widely used, central banks’ monetary policy will nevertheless remain effective. The possible impacts of digital-based payments on monetary policy could be summarized as follow:

First, if crypto-assets, which are not denominated in sovereign currency units, become widely used for daily transactions, instead of domestic sovereign currencies, the effectiveness of monetary policy could be substantially impaired. Theoretically, this situation is similar to the process of “dollarization,” where foreign currencies are widely used instead of domestic currencies. As mentioned earlier, crypto-assets are nonetheless unlikely to be used as daily payment tools.

Second, even if digital-based payment instruments are issued as the liabilities of banks or used as tools to issue instructions to transfer bank deposits, the effectiveness of monetary policy will not be impaired. Indeed, many payment instruments of that type, such as checks, credit cards and debit cards, already exist and they have not seriously impaired the effectiveness of monetary policy.

Third, if non-banks make use of their own liabilities denominated in sovereign currency units as payment instrument, such as Paypal, AliPay, WeChatPay and M-Pesa, central banks will have to consider several new issues. For example, they may need to consider how monetary aggregates, which have traditionally been defined as bank liabilities, should be re-defined in order to remain useful indicators for monetary policyies. As these instruments may work as large-scale netting services operated by non-banks, they could put downward pressure on monetary aggregates while increasing their velocity, if the current definition of monetary aggregates is maintained. In addition, central banks may be required to consider the way in which these non-banks should be monitored, and whether they should be allowed to access central bank facilities and credits. These issues may require overhauling statistics and institutional frameworks. Therefore, even if digital-based payment instruments provided by non-banks develop, central banks will be able to maintain the effectiveness of their own monetary policy. In sum, the possible impacts of the digitization of payments on monetary policy can be properly handled, and monetary policy will remain effective in the foreseeable future.

The LLR function of central banks will still be needed if banks continue to engage in maturity transformation. Moreover, as long as domestic sovereign currencies are widely used for payments and settlements, the central banks’ capacity to issue and provide sovereign currencies will remain effective in mitigating liquidity problems. Needless to say, central banks will be expected to monitor not only the activities of commercial banks but also of entrants in the financial services industry, in order to maintain payment, settlement and financial stability.

3.5 The number of “full-line” central banks will decrease in the long run

Due to the globalization of the economy and the increase in cross-border transactions, there is growing interest in currency unions, which could reduce transaction costs, other things being equal. However, if a common currency is not backed by a robust institutional framework to support its trust and credibility, it could fuel risks for the nation’s economy. In the future, due to the increased trend towards currency unions, the number of central banks is expected to decrease in the long run. (Some central banks will remain as overseers of payment, settlement and financial systems and operators of central bank infrastructures even though they no longer are sole issuers of their sovereign currencies.)

Nonetheless, the success of currency unions may depend on whether they can organize, beyond the established system of modern nation states, effective institutional frameworks, allowing them to create and maintain trust and credibility. These frameworks may include various factors such as coordinated legal systems and sufficient discipline among various policies, especially fiscal policy. There is still a long way to go before central banks and nation states manage to establish such frameworks across borders.

3.6 The Future of central banking will be closely linked to that of nation states

Central banks are undoubtedly one of the great inventions of the modern economy, and their history cannot be separated from that of post-seventeenth-century nation states. Indeed, the framework of nation states has worked as a “trust machine” backing up modern central banking.

Within a relatively short period, central banks worldwide have established a globally-shared style in which the central bank of each state is the sole issuing authority for the sovereign currency. Within this framework, central banks provide paper-based banknotes to everyone for daily payments, and they give access to central bank accounts and large-value settlement systems mainly to banks. They also conduct the monetary policy and function as lenders of last resort.

Since the beginning of this century, the traditional models of central banking have faced various new challenges: many non-banks have been engaging in financial services, and various new factors have emerged, such as big-data, global platforms, cloud computing and AI, which could potentially assume systemic importance. Many of the new technologies could be applied to central banking.

Recent innovations, including crypto-assets, suggest that trust and credibility will remain the mainspring of money and of central banking. In this regard, the power and relevance of central banks depend on their trustworthiness and credibility, which only robust institutional frameworks and good policy records can give.

Ever since central banks were established, their trustworthiness and credibility have been supported by the institutional framework of modern nation states. For example, the independence of central banks, which is an important requisite for their trustworthiness and credibility, is supported by each nation’s legal framework, and besides, cash is given the status of a “legal tender”. In this regard, whether central banks will take a different form in the future depends on whether we find a more efficient system to establish their reliability than current nation states do. Crypto-assets that are independent from nation states are not widely used because in terms of trust, they are not as effective as the current « trust machines ».

It is also necessary to closely monitor the impacts of globalization on central banks. Due to the increase in the number of transactions and capital flows across borders, international cooperation and coordination is more and more vital if we want central bank policies to remain effective. In addition to monetary and currency unions, various efforts are being made to establish an international financial architecture. In order to effectively monitor and oversee the activities of global financial institutions and infrastructures such as Global Systemically Important Financial Institutions (G-SIFIs), close communication and coordination among central banks is crucial. After the Global Financial Crisis, central banks have intensified their efforts on this front, with various forums such as the Bank for International Settlements, Financial Stability Board and Supervisory Colleges.

3.7 Quantitative easing will affect central bank policy conducts in the near future

With a disinflationary trend and a zero lower bound on nominal interest rates, several central banks in developed economies, such as the Federal Reserve, the European Central Bank and the Bank of Japan, have engaged in quantitative easing (QE). Since it may not be realistic for central banks to sell a huge amount of government securities on an outright basis, they will be expected to maintain substantially large balance sheets, at least in the near future. Holding large balance sheet means that these central banks carry interest rate risks as the maturity gap between their liabilities and their assets including long-term government securities is substantial.^[33] It will be necessary to monitor whether and how the financial conditions brought about by the adoption of QE will affect their policy conducts.

Moreover, since the effectiveness of QE remains hypothetical to a certain extent,^[34] further evaluation of the benefits and costs of QE might also influence the reputation and credibility of these central banks, especially if they it takes time for them to completely exit from QE.

3.8 The Future of central banking will be linked to data utilization

As far as processing information and data is concerned, money has translated the value of various goods and services into prices with common units, and enabled price mechanisms to function effectively. Thanks to money, we can measure “general price levels” and “inflation”, which is indispensable for the conduct of a monetary policy. As such, money works as a critical tool for processing information and data in the economy.

In the current two-tiered monetary system, most central banks operate large-value settlement systems for a limited number of entities, such as banks. Through operating these systems, central banks obtain the information and data they need for maintaining the overall stability of payment and settlement systems. On the other hand, in so far as banknotes are “anonymous” instruments, central banks do not have access to the information and data attached to daily transactions carried out by ordinary people. This data has long been exploited mainly by private hands.

As digital-based “cash-less” payment instruments develop, they are playing a greater role in collecting and processing a variety of data as economic transactions are almost always accompanied by payments and settlements. As the development of digital-based payments accelerates the accumulation and utilization of customer data, money and data are bound to become more closely interlinked with each other. Today, many giant IT firms known as BigTechs are providing digital-based payment services for free. These firms tend to use payment services as a platform to collect customer data, and utilize these data for a variety of purposes, while users give away their own data as a substitute for a fee. As firms offer discounts or rewards to users of digital-based payment instruments, the users purchase goods and services in exchange for their own data instead of paying money.

As digital innovation enables payment instruments to function as tools for conveying and processing a variety of data, ensuring data security, privacy and anonymity is becoming a crucial issue in the financial services industry. Therefore, central banks will be expected to monitor the way in which the relevant parties obtain, store and utilize the data attached to digital-based payment instruments. Besides, central banks will also need to consider the way in which they store and use the data obtained through their own infrastructures, including RTGS systems. This could be one important issue regarding CBDC.

The data revolution is changing the structure of the economy and of financial markets. In such an environment, whether we can use data safely and effectively will substantially influence the efficiency of the economy. In this regard, one of the critical issues regarding CBDC is its impact on the use of data. If CBDC replaces not only cash but also private-based payment instruments, central banks, instead of private entities, will be able to accumulate the data attached to payments. In designing their infrastructure, central banks will have to define the optimal style and distribution of roles regarding the use of the data attached to economic transactions. Efficient sharing and utilization of data among the central bank and private entities will be critical for a sustainable economic development and for people’s welfare in future.

For example, financial institutions used to gather financial data while non-financial companies mainly collected non-financial data. But with the kind of digital-based transactions entailed by e-commerce, financial and non-financial data are increasingly interlinked with each other. In this environment, various new payment instruments have been developed so that a wide range of private entities can collect and utilize not only financial but also non-financial data. Needless to say, a more effective utilization of data may enhance the efficiency and the welfare of the economy.

In this regard, even though CBDC could enhance the efficiency and safety of each payment, if it “crowds out” private-based payment instruments, the volume of data available to private entities might decrease. It might not be easy for central banks themselves to fully utilize the data accumulated through CBDC. In addition, the accumulation of gigantic amounts of data by the central bank might raise sensitive issues regarding its independence, especially if these data could potentially be exploited for other purposes, like taxation, crime prevention and other administrative concerns.

3.9 Epilogue – central banking in a decentralized world –

In 2008, which was only a decade ago, we were in the midst of a global financial crisis. At that time, crypto-assets and blockchains were nowhere in sight. The iPhone, Kindle, Uber and Airbnb were still in their infancy. Nobody ever pressed the “Like button” of Facebook or Instagram.

Since then, within just a decade, the number of smartphones has increased dramatically, and BigTech firms known as “GAFA” and “BAT” have grown very rapidly and have become top global firms in terms of market capitalization. These instruments and firms are now playing important roles also in the financial services industry. Now, smartphone apps, digitized books, Facebook’s “Like button” and “instagramable” photos are deeply embedded in people’s daily lives. It only took a decade for all of this to happen.

Since the speed of changes seems to accelerate, the changes in the next decade are likely to be even faster than those of the last decade. As a thought experiment, we can even imagine that money, at present an intermediary for various goods and services, will no longer be needed in the distant future, on condition that the capacity and networks for processing information and data develop further and people can directly and instantly agree on the exchange of goods and services they need and ensure the execution of these agreements without any uncertainty.^[35]

As long as a substantial element of uncertainty hangs over the economy and people’s lives, money and central banks are unlikely to disappear. Nonetheless, the on-going digital innovations and data revolution are influencing money and central banking in various ways, and central banks need to think about a way for them to remain relevant in a digitized world with de-centralized technologies.

Central banks are characterized as “central” entities. After the establishment of modern nation states, each nation tried to establish one single entity that was credible enough to be the sole issuer of sovereign currency. In order to make its central bank sufficiently credible, each nation spent substantial resources on building its trust through the constitution of legal and institutional frameworks, including central bank laws and the recognition of banknotes as legal tenders, while making the central bank accountable to democratic processes. The establishment of modern nation states has made it possible for a centralized structure to establish its trustworthiness and credibility. This framework will continue to be effective as long as nation states and accompanying institutional frameworks such as nation-based legal and tax systems are maintained. In this regard, the future of central banking is closely linked to the fate of nation states and depends on the development of an optimal framework for building trust with every available technologies. Although several initiatives towards currency unions have been taken, it seems that the world has not yet found a framework that could rival the current modern nation system. It should also be noted that the future of central banking is also closely linked to the ways in which information and data can and should be utilized in the future. Indeed, this issue is critical for achieving sustainable economic development in the era of the data revolution.