Revisiting the Monetary Sovereignty Rationale for CBDCs

The current monetary sovereignty argument for central bank digital currencies (CBDCs) is that without them, private and foreign digital monies could displace domestic currencies—a process called currency substitution. This would then threaten a central bank’s ability to effectively conduct monetary policy and act as a lender of last resort (LLR). I suggest that this argument provides an important but incomplete picture of the consequences and risks of currency substitution from a monetary sovereignty perspective.

I seek to expand and enhance this picture in three ways. First, I look at consequences of currency substitution that go beyond the functions of a central bank—important considerations that have received less attention in public CBDC discussions. Second, I explore key differences in monetary policy and LLR capabilities across currency-issuing countries or regions. More specifically, I highlight the variation in the degree of monetary sovereignty and the consequences that different countries face should they lose it. Third, I assess not only the implications but also the risks of currency substitution and show how these, too, are likely to vary across countries.

I conclude by pointing out a potential inverse relationship between the impact and probability of a country losing its monetary sovereignty.