Revisiting the Monetary Sovereignty Rationale for CBDCs

As currently articulated, the monetary sovereignty argument for central bank digital currencies (CBDCs) rests on the idea that without them, private and foreign digital monies could displace domestic currencies (a process called currency substitution), threatening the central bank’s monetary policy and lender-of-last-resort (LLR) capabilities. This rationale provides a crucial but incomplete picture of what is at stake in terms of monetary sovereignty. This paper seeks to expand and enhance this picture in three ways. The first is by looking at the consequences of currency substitution that go beyond the functions of a central bank—important considerations that have received less attention in public CBDC discussions. The second is by exploring key differences in monetary policy and LLR capabilities across currency-issuing countries or regions. More specifically, the paper highlights the variation in the degree of monetary sovereignty and the consequences that different countries face should they lose it. The third way is by assessing not only the implications but also the risks of currency substitution and showing how these are also likely to vary across countries. Contrasting the consequences and risks of substitution, the paper concludes by noting a potential inverse relationship between the impact and probability of losing monetary sovereignty.