CBDCs can help central banks tame inflation

Lack of correct, timely data hinders monetary authorities in their fight against rising prices

As central banks implement policy rate hikes around the globe, the risk of synchronous and mutually-reinforcing recessions is growing. The International Monetary Fund predicts that a third of world economies will enter recession in 2023.

‘Soft versus hard landing’ debates all stem from one issue that has plagued central banks since the beginning of this bout of inflation: data, or rather the lack of it, for central banks to analyse their respective economies – particularly the rate of inflation and the effect of policy rate hikes on the real economy. The data and policy tools enabled by central bank digital currencies provide a way to significantly reduce this risk.

When modelling the impact of policy rate hikes, the US Federal Reserve staff and its board of governors keep a close eye on indices measuring the price of goods and services. Healthcare is increasingly prominent in the basket of important services. As explained by Omair Sharif, founder and president of Inflation Insights in Bloomberg’s ‘Odd Lots’ series, the process by which healthcare prices are measured is very different from the way prices of a monthly consumer price index report are measured.

Healthcare price changes are not measured the same way food or durable goods are measured via monthly surveys or store visits. Rather, the Bureau of Labor Statistics, in charge of measuring CPI in the US, measures the cost of a business to offer health insurance: if the cost of health services to businesses rises then inflation rises and premiums go up. The current way of capturing this information is via the reported annual profit margins of insurance companies, released once a year by the US National Association of Insurance Commissioners, typically in autumn. As demonstrated by Sharif, the impact this survey has on the monthly CPI reports for healthcare is extremely strong (Figure 1).

Figure 1. Irregular healthcare price measurement causes major October CPI swings

CPI change month to month, %

Source: Omair Sharif, Inflation Insights

Many other CPI reports across the world are currently measured in this manner: asset and liability information submitted by market participants to central bank regulators is dated (multiple quarters behind), frequently incomplete and sometimes simply incorrect.

Translating this torrent of information into a meaningful index of price inflation or financial risk for individual banks, and the financial system overall, involves a lot of sophisticated guesswork for central banks. Moreover, economists’ attempts to statistically model the propagation of inflation effects or financial stress through the banking system are constrained by the relative infrequency of business cycle contractions and the opacity surrounding much of this information.

This flawed methodology does not need to be used: current CBDC architecture provides central bank economists and regulators with a wealth of near real-time information on the CBDC balances of financial institutions, along with metadata that could tag which industry each CBDC is spent in, allowing real-time CPI measuring and even triangulated inflation fighting, while maintaining robust privacy of all transactions for all users. A central bank doesn’t need to wait for institutions to report its CBDC assets and liabilities; instead, central bank staff can query the CBDC balances directly.

As we fight inflation in 2023, lessons learned can be used to give central banks the tools they need to manage their economies in a better manner, rather than possibly engineering unnecessary recessions.

James Shinn is Executive Director, Simon Chantry is Co-founder and Chief Information Officer, and David Bahamon is Digital Currency Strategy Manager at Bitt.

This article was originally published in the Digital Monetary Institute annual 2023.

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