Central banks in Europe are stuck in a corner. Their interest rates are at or below zero and now the economies in Germany and Italy are dropping into recession while markets panic and need further monetary stimulus. The problem is that central banks cannot cut interest rates well below zero because they risk a bank run where investors take their money out of the bank to keep it in cash at home at zero interest rates. As Ken Rogoff has proposed, reducing the availability of large denomination bills, or even abolishing cash altogether, would be a measure that could help central banks circumvent this zero lower bound and open up the possibility of interest rates that could go far below zero.
One of the countries that suffers most is Sweden, where the central bank has only now managed to increase the repo rate back up to 0% from -0.5%. At the same time, Sweden has the advantage that its economy is far advanced in the introduction of electronic payment systems and hence, the currency in circulation in Sweden is one of the lowest in the world. Sweden is just one step away from becoming an entirely cash-free society.
Currency in circulation as share of GDP
Source: IMF, World Bank.
A little more than a month ago, the Riksbank announced a pilot-project to test the efficacy of replacing cash with a central bank issued digital currency, called the e-krona. The idea is to use blockchain technology to circulate an electronic coin that can only be issued by the central bank but is accepted widely by banks and retail stores. This cryptocurrency is based on the company R3’s Corda platform, which has several advantages compared to traditional cryptocurrencies like Bitcoin, most importantly the lower energy consumption and greater scalability as a payment solution.
However, given the need to act decisively in the face of the Covid-19 epidemic and given the positive experiences with the trial so far, the Riksbank has now decided to introduce the e-krona nationwide at the end of the trial period in February 2021. Simultaneously, the Riksbank will start to phase out physical cash over a period of approximately five years, starting with the highest denomination bills, which will be withdrawn from circulation by end of June 2021. These actions are also in line with the findings of the review of the concept of legal tender and the role of physical cash in a digitalised economy.
“We think that the concept of legal tender should be technically neutral so that it fulfils a function even in a digital future”, said Riksbank Governor Stefan Ingves, adding that abolishing cash would enable the Riksbank to cut interest rates well below -1% if need be. This way Sweden’s economy could be better protected from the fallout of a slowing economy in some of its largest trading partners. Asked about Swedish savers who would face rapidly declining savings held in bonds and bank deposits, the Governor shrugged and said it would be a good time to buy houses or build a home sauna…