Lambert here: Or, see, I could arrange to have my 5G account checked and automagically topped up every hundred yards or so, wherever there’s a 5G tower, right out of my digital wallet. Convenient! Unless the Central Bank were running a bail-in, of course…
By Emanuele Borgonovo, Professor, Department of Decision Sciences, Bocconi University, Stefano Caselli, Professor of Banking and Finance, and Vice-Rector for International Affairs, Bocconi University, Alessandra Cillo, Adjunct Professor of Decision Sciences, Bocconi University, Donato Masciandaro, Full Professor of Economics, and Chair in Economics of Financial Regulation, Bocconi University, and Giovanni Rabittt, PhD student in Statistics, Bocconi University. Originally published at VoxEU.
Alongside liquidity and store of value, is privacy an important attribute of money? Using laboratory experiments, the column shows that privacy matters, and increases the overall appeal of money. The experiments suggest that future competition between alternative currencies will depend on how the three properties are mixed.
The protection of privacy is a crucial issue. In monetary economics, can privacy play a role in explaining demand? In other words, could privacy be a third attribute – with liquidity and store of value – that can explain demand for both traditional and new media of exchange? These media may already exit (cryptocurrencies, for example) or soon exist (central bank digital currencies).
For macroeconomists, there are three interesting trends:
Therefore, a natural question arises: does money demand depend on privacy? Recent research, working on the intuition that any kind of money can be considered a memory store (Kocherlakota 1998), has focused on the association between money and privacy of transactions (Athey et al. 2017, Fernandez- Villaverde 2018, Kahn 2018, Masciandaro 2018). But it is not clear that this relationship is so relevant and general that we should consider privacy as a third property of the demand for money.
Experiments About Privacy and Money
Borgonovo et al. (2019) propose a novel specification of the demand for money as a medium of payment with the following three properties:
We tested the robustness of this new specification with laboratory experiments using the Prince method (Borgonovo et al. 2019).
The experiments used a three-stage procedure. First, the subjects stated their preference among alternative media of payment. In this first stage, the media of payment differ only in anonymity. This reveals the preference for privacy. The second stage tested the relative importance of privacy with respect to liquidity and store of value. Finally, in a context of complete anonymity, we measured the trade-offs between illiquidity risk and devaluation risks.
There were five main results:
Paper Money Abides, Cryptocurrency Has Weaknesses, and Digital Cash Has Challenges
If privacy matters as a property of money – as the results suggest – then paper money can maintain its appeal as an anonymous medium of payment, but the more other media can be trusted to offer privacy while balancing illiquidity risk and devaluation risk, the more likely it is that paper money will be crowded out.
There are policy implications for medium of payment suppliers such as private and central banks, and non-banking firms. Banking monies could be challenged as media of payment by a lack of privacy, and if there is a high devaluation risk. In parallel, the success of a cryptocurrency will depend on its ability to overcome illiquidity and devaluation risks, while increasing the credibility of its claim to privacy.
Finally, regarding central bank digital cash – uniquely promising the potential to be both an electronic medium of payment and a public currency – the experiments suggest that its attractiveness will crucially depend on privacy design today, and later its interest-bearing mechanisms. In normal times the illiquidity risk of a central bank digital cash would be zero, but it seems unlikely that individuals will consider it anonymous in the same way as cash is already anonymous. Offering a yield could be a trigger to increase its competitive appeal.