Breaking the Gilt Standard: The Problem of Parity in Kumhof and Noone's Design Principles for Central Bank Digital Currencies

This paper is a critical engagement with the four design principles for Central Bank Digital Currency (CBDC) recently proposed by Kumhof and Noone (KN). It is argued that the implicit notion of parity underlying KN's analysis is too narrow as it is only focused on the exchange rate between CBDC and bank deposits. Instead, we develop a three dimensional model of parity, which also includes the concepts of purchasing power parity and settlement parity. Applying this model to KN's proposal, the paper identifes four potential breaking points, where their principles provide a weaker defense of parity between CBDC and bank deposits than what is suggested by their analysis: Gilt traders may create a break of purchasing power parity as they respond to a crisis by quoting different gilt prices depending on whether payment is made in CBDC or bank deposits. Speculators may provoke a break of either purchasing power parity or exchange rate parity by buying gilts for bank deposits, thus forcing the central bank to buy gilts for CBDC, and then subsequently selling gilts for CBDC. The Treasury may find itself forced to break settlement parity, if citizens create a 'run' by using only bank deposits to make payments to the government, while demanding payments from the government in CBDC. And finally the central bank cannot use the interest rate on reserves as a separate policy tool to guide the risk-free interest rate in the economy as reserves carry the risk of a break of settlement parity in relation to CBDC.