A Proposed Central Banking Model to Mitigate Inflation*
Taylor Moffitt of Halydean
Abstract
This paper proposes a Central Bank Digital Currency (CBDC) conceptual framework as a dual currency and dual interest rate central banking model that is geared at curbing inflation, while simultaneously stimulating key economic sectors. The proposed central bank rate bifurcation model is described including, but not limited to a mechanism that will incrementally back existing fiat currency with CBDC stablecoins. Some metrics for evaluation, concerns and opportunities, and the role of technology are discussed. Potential downsides include political abuses, over-consolidation, hostility from the blockchain community, and the iterative process of optimizing this model. Expected results and some additional cautionary considerations are presented.
JEL Codes: E42, E43, E50, E52, E58, E59.
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*I would like to thank Niall Ferguson for his qualitative historical research, Erl Morrell-Stinson and Chris McGovern for encouragement and inspiration. I would also like to especially thank Aaron Brown and Mark D. Harris for contributions and edits to this paper. This paper was financially supported by The Michael & Reba Moffitt Trust. Author contact: halydean@proton.me. The views expressed in this paper are those of the author and do not necessarily represent the views of anyone above.
Introduction
In central banking, the ability to raise and lower the fed funds interest rate is the primary tool of monetary policy (Paese, 2023). The problem with the current central banking model of raising or lowering a single interest rate, to either stimulate commerce or curb inflation, is that it forces central banks to make an either/or choice between two desired outcomes. The choices are then effectively limited to, slow down the economy, or cause inflation (Greider, 1989). The objectives of the model presented in this paper are to give central banks new tools with which they may not only have the powers of gas and brake, but also to have the ability to steer the economy in strategic directions. This is significant because it provides an alternative to the desired outcomes of stimulating commerce or curbing inflation. This may present the means for central bankers to combat difficult challenges such as stagflation.
Relevant Literature Selections
Central Bank Digital Currencies (CBDCs) are a prominent and evolving topic in the field of financial econometrics, monetary economics, and central banking that are increasing in popularity rapidly (Auer, Cornelli & Frost, 2023). The following selections from the literature provide an overview of some concepts, findings, and trends that are specifically relevant to the proposed dual currency and dual interest rate model.
Repressing Inflation.
A negative side effect to monetary policy is inflation (Greider, 1989; Paese, 2023). By raising interest rates, central banks aim to reduce borrowing and spending, which can cool down the economy and reduce inflationary pressures. Conversely, banks may lower interest rates to stimulate economic activity when inflation is less critical (Shirakawa, 2021). CBDC technology has opened the door for central banks to have more tools than just this power of gas and brake. The model proposed in this paper is intended to be compatible and used in combination with any other mechanisms of mitigating inflation, such as regulatory measures, open market considerations, and quantitative easing (QE).
Stimulating Affluence
Robert Shiller (1990, 2014) has shown that crowd psychology is an important consideration in determining the value of assets in the financial markets (Bourghelle et al., 2023). It may be rational to assume that the models of crowd psychology could apply to currency markets and currency valuations as well. It can be synthesized from this that a good system of controlling inflation should include public education, implemented in a gradual manner so as to allow the markets to have time to adapt psychologically to the new system as it is being implemented.
Niall Ferguson (2010, 2011, 2012) has made substantial contributions to the study of the common factors that preceded economic growth in the field of history through deep qualitative analyses of historical trends and patterns, particularly in the great divergence of the substantially stronger Western economy from the rest of the world (De Zwart, 2011; Moosa, 2023). Ferguson’s research identified six (6) prevalent key ideas and institutions that precede periods of economic growth: “competition, science, property, medicine, consumption, and work” (Ferguson, 2012, pp. 19, 50, 96, 141,196, 256). Free market competition, particularly the advent of corporations and financial markets, allowed the most valuable producers to grow. The scientific revolution, spurred by educational institutions, promulgated, and encouraged advancements in technology. The rule of law based on private property rights, especially the widespread private ownership of land, encouraged vast numbers of individuals to be as productive as possible. Modern medicine was helpful because it has increased people’s productive life expectancy. The consumer society encouraged the purchase of goods and services so that people were inclined to use their wealth to support the system, which is diametrically opposed to a society based upon minimalism and contentment in permanent institutionalized poverty as promoted by Mahatma Gandhi. The work ethic is there when the institutions encourage individuals to work hard (Ferguson, 2011).
It can be synthesized from Ferguson’s work that the six ideas and institutions could be translated into specific areas of funding for strategic monetary policy. The corresponding targets proposed are (1) lending for state of the art financial markets and rewards for the profitable corporations, (2) lending to build educational institutions and provide student loans, especially to advance technology and innovation, (3) lending programs to encourage, for as many families as possible, the widespread private ownership of agricultural land, residential land, land development, utilization of natural resources and private ownership of businesses, as well as the infrastructure to support all of those engines of prosperity, (4) lending to build colleges and provide student loans to educate and train healthcare workers, and to build hospitals and healthcare facilities to increase life expectancies, (5) lending for businesses and infrastructure that promote the consumer society, and (6) lending to incentivize a work ethic can fund performance-based rewards such as, student loans, entrepreneurial loans and easy access to credit for those with high credit scores.
When a central bank has two different interest rates, the interest rate bifurcation model proposed in this paper can selectively favor the areas of infrastructure deemed to stimulate prosperity by Ferguson (Ferguson, 2012). When targeted, these factors could benefit from lower interest rates while other non-critical factors could help to control inflation with higher interest rates. Companies such as those that are developing new technology, promoting education, purveying health and wellness, and building the other key areas such as commerce, trade, infrastructure and globalization, could be able to borrow at lower rates so that they might be encouraged to grow and bear the fruit of prosperity, according to the sectoral approach to monetary policy (Kreamer, 2022).
Geographic differentiation may be necessary because of differences in infrastructure and natural resources between various nations. One representative example of this could be desalination plants to supply water in arid nations to help encourage the underlying industries that will eventually lead to increased autonomy and more exports. Another example could be agricultural cooperatives to equip farmers to enjoy the benefits of scale. As domestic resources are developed, vertical integration for the ability to process and resell them for a value-added domestic revenue stream and increased product and commodity exports should be next. Numerous examples of investment opportunities could be listed, but this probably should be the subject of future research so that strategic target areas can be prioritized.
Conceptual Frameworks
If practitioners implement two different interest rates in a central bank, where a lower interest rate is applied to support the building blocks of industry and infrastructure while a higher interest rate is used for other purposes, there are a few applicable conceptual frameworks. Some of the various conceptual models that support this tactic follow.
Dual Mandate of Central Banks. Many central banks operate under a dual mandate including price stability and economic growth or employment (Debortoli, et al., 2019). By applying two interest rates, central banks can tailor their policy to address both aspects of their mandate more effectively. A lower interest rate for industry and infrastructure can promote economic growth and employment, while a simultaneously higher interest rate can address inflationary pressures, contributing to price stability.
Monetary Policy Transmission Mechanism. The transmission mechanism of monetary policy has become increasingly complex, but still describes how changes in interest rates affect various sectors of the economy (Koop, et al., 2009). However, there are still potential problems with targeting asset prices (Mishkin, F.S., 2001). By using dual interest rates, central banks can fine-tune the monetary policy transmission mechanism to provide targeted support to specific sectors, such as industry and infrastructure, without causing the potential problems of broad and general inflationary pressures.
Sectoral Approach to Monetary Policy. Some economic models advocate for a sectoral approach to monetary policy. This approach recognizes that different sectors of the economy respond differently to changes in interest rates, and neglecting these differences can cause substantial losses (Kreamer, 2022). Rather than focusing on complex metrics, a lower interest rate for specific sectors can stimulate investment and growth, fostering the development of the infrastructure and industries deemed to be critical.
Financial Stability. Dual interest rates may contribute to financial stability by differentiating between speculative and productive investments. A higher interest rate for non-productive or speculative activities can help mitigate asset bubbles and excessive risk-taking, while a lower interest rate for productive investments can support sustainable economic growth.
Income and Wealth Distribution. To help the poor, they must be included in the mechanisms of prosperity. The poor must become benefactors, not just supplicants of the prosperity of others within an increasing welfare state. Dual interest rates can be seen as a tool for addressing income and wealth inequality. By promoting investment in essential industries and infrastructure, these seeds of prosperity then can elevate the entire financial system, especially by promulgating easy access to capital for entrepreneurs, first time homeowners, seed banks, start-up agricultural cooperatives, and other strategic sectors. When this CBDC model is combined with a transactional blockchain tax, wealth distribution is inherently improved as bigger spenders will automatically and inescapably pay more taxes. Central banks can contribute to a more equitable distribution of wealth and income by elevating the prosperity of the entire system, which can align with certain economic equity ideals.
Counter-Cyclical Policy. Evidence suggests that countercyclical policy at the governmental level needs major revisions due to its inadequacy (Rocco, et al., 2020). Central banks can better apply counter-cyclical efforts to stabilize the economy by implementing different interest rates based on the stage of the economic cycle. This is consistent with the purpose of counter-cyclical policy. When multiple interest rates are averaged, lower mean interest rates for industry and infrastructure during economic downturns can stimulate economic recovery and employment, while higher mean rates during economic booms can prevent pricing bubbles and inflation.
Economic Development and Infrastructure Investment Theories. Theories related to economic development and infrastructure investment emphasize the importance of developing critical infrastructure, which will serve as the backbone of economic growth (Dang & Pheng, 2015). When doing this there is a need to differentiate between different regional and sectoral infrastructures, because nations differ in their needs (Guo, et al., 2023). The ability to establish a lower interest rate for specific sectors of infrastructure and industry aligns with these concepts, promoting long-term economic development.
Financial Inclusion and Access to Credit. If interest rates are lowered for small and medium-sized enterprises and entrepreneurs, supporting their growth and development, this will improve financial inclusion and access to credit for those small and medium-sized business owners. The success of this good intention will largely depend upon how it is promoted by governments and implemented by banks. This would provide a pathway for the poor to become part of the mechanisms of prosperity.
Proposed Conceptual Framework Description
The structure and mechanics of the proposed conceptual framework are described in detail. This includes the nature of the dual-currency concept, the dual-interest-rate concept, prudential asset backing, graduated fiat currency backing, and targeted key sectors. Other helpful stabilization strategies are proposed in this section as well. These include currency pegging strategies, arbitrage apps, introducing the model as a wholesale CBDC only, blockchain dividends as a means for reconciling differing fundamental values between fiat and stablecoin, and transactional taxes as a means to offset initial costs.
Figure 1. Flowchart of proposed CBDC conceptual model
Dual Currencies.
The CBDC that is created should be used in conjunction with the traditional fiat currency that is already in use. The CBDC should be an asset-backed stablecoin because stablecoins backed by algorithms alone are potentially prone to collapse (Li, et al., 2024). Axiomatically speaking, if the CBDC is backed by assets that appreciate in value during times of inflation, a CBDC should, in the absence of other confounding variables, have an upward bias to appreciate in value relative to the fiat. Some proposed strategies might allow them to both have the same value. One proposed strategy is to gradually use the CBDC to back the fiat, and announce an interchangeability policy, which is described below, assuming parity pricing between the two different currencies. As legal tender, the CBDC can eventually be used by a smaller number of early adopters and can be allowed to naturally grow in acceptance and retail use by the public. In time, the digital currency can become just another interchangeable means of payment in the same currency, much like cash, checks, or credit cards are different means of the same currency. Keeping dual currencies will allow ample time for a natural acceptance and adoption by the public, and for any needed retail infrastructure to have time to be put into use. There are too many possible confounding variables to predict, but allowing both currencies of equal value to peacefully coexist together could prevent some of these unforeseen disruptions.
It is important to initially keep both fiat and digital currencies in full use so that there is a clear and easy mechanism by which to bifurcate the central bank interest rates. After time, systems can evolve through iterative processes to allow dual interest rates with CBDC. It is a simple matter to create two different types of CBDC coins that appear to be the same to end users, but differentiation in their coding can allow banks to easily keep track of which ones belong to which interest rates. To initially use one CBDC and one fiat currency to clearly differentiate the two interest rates at first is recommended however, because it will make interest rate lending compliance easier. Two different currencies, even if they are of the same value, will help bankers to ensure that lower interest rates are only going to the appropriate areas.
Dual Interest Rates.
If the CBDC is used to fund the lower (“Stimulus Interest Rate Class”) interest rates, this will help to improve CBDC traction and acceptance in the business community. Meanwhile, the higher (or more euphemistically, “Normal Interest Rate Class”) interest rates can be applied to the traditional fiat currency. After the central bank has clearly qualified and defined a highly specific lending matrix to categorize various projects, it will be easier to allocate the lower interest rates to certain projects. Each commercial bank in the central bank network can begin to receive CBDC funding that is only valuable to banks, individuals, and entities that have created digital identities at the commercial banks.
In this way, the banks can clearly tell the difference between stimulus money and normal money and can easily request more money from central banks respectively. Later, as fiat money is gradually phased out of circulation, the interest rates can be differentiated by simply including the difference in the blockchain code. Retail users will see the money as all being the same, but bankers can perhaps see one show up as blue and the other as green, for example, to clearly differentiate the two so that interest rates are properly set. If more than two interest rates are used, the CBDC can be minted in multiple interest rate classes which would not affect the retail functionality of the money at all. In this way, the CBDC can be implemented first as a wholesale only CBDC, and the retail side can be added later. This will ensure that there is no market for the theft of the CBDC for nations that do not yet have sufficient identity-based blockchain to satisfy their anti-money laundering and customer identification requirements. Wholesale-only initial implementation will also help to ensure that there is no drop in the use of banks, as a purely distributed ledger CBDC system would circumvent banks in general.
Prudential Asset Backing.
For assets to back the CBDC stablecoin, portfolio assets should be selected to build stability and mitigate inflation. These are classified by the Basel Committee on Banking Supervision of the Bank for International Settlements as “Group 1b Stablecoins,” and central bank compliance applies respectively (Basel Committee on Banking Supervision, 2022, p. 2-4). The central bank should hold these assets with whatever mechanism of possession or lien holding is customary, prudent, lawful, and most convenient within that nation. Care should be taken to avoid portfolio overweighting with assets that are illiquid or unreachable so that the currency will meet the approval of any bank examiner or currency analyst. In-ground assets should only be those which are creditworthy and suitable for any retail bank’s collateral. It should be noted that there are some privately issued blockchain “stablecoins,” trading among crypto speculators, that are backed by assets of questionable values. These would-be assets are not credit-worthy current project valuation appraisals but are Canadian National Instrument 43-101 Standards of Disclosure for Mineral Projects (Fox, 2017). As a representative example of the potential false hope in worthless backing that unbankable assets could generate, if everyone in the world with in-ground assets were to tokenize their in-ground fortunes one could speculate that the world’s entire money supply might be recreated a billion times in so called asset-backed stablecoins. There would be nothing stable about such a silly effort. To think that a CBDC backed by such a scheme could stave off inflation is naive considering the abundance of in-ground assets. After all, the whole planet is made of in-ground assets. Because of this, the assets used for currency creation must be prudential by traditional bank lending standards and located within each bank’s geographic lending area.
Graduated Fiat Backing.
Anecdotal experience from almost anyone with experience as a trader suggests that when a struggling entity makes an optimistic announcement it is usually met with short selling. With that in mind, if a nation that has been plagued with inflation suddenly announces good news, forex traders could respond cynically by calling a bluff. Shiller has shown that fundamentals alone are not enough to drive market prices in the field of financial econometrics (Shiller, 2014). The market might be skeptical, but after 3 weekly announcements and the clear intention to fully back the fiat, traders might consider the announced intentions to be legitimate, and would eventually quit shorting the fiat currency out of fear that something good is happening. This would be the start of a substantial inflation mitigation. It should be announced that the currency will eventually be fully asset-backed by the new asset-backed CBDC, and consumers will eventually be able to trade their fiat at any time for the new digital currency, which can be held in accounts at their banks for security or held in their own crypto wallets if they so choose. The market should be given plenty of time to adjust. This could be a weighty new valuation factor for the soon-to-be fully asset-backed fiat currency. A case study of the Brazilian Cruzeiro reveals that it is important to allow the public plenty of time to psychologically adjust to changes and develop trust in the value of the new currency. Good fundamentals alone were not enough to stop the Cruzeiro’s inflation (Lopes, 1988, Carvalho, 2023, Schiozer & Terra, 2023). It can be synthesized from Shiller’s work and even a brief study of the Cruzeiro to Real switch in Brazil that crowd psychology and public education are going to be paramount for the success of an asset-backed CBDC.
Targeted Key Sectors.
The purpose of bifurcating the central bank’s interest rates within a given area is so that stimulus can be applied to the infrastructure and building blocks of prosperity within that area whilst curbing inflation with higher interest rates in less critical areas. Niall Ferguson identified six precursors of cultural affluence in his qualitative historical studies. Because history repeats itself, it is recommended that these six prospective areas should be the target areas of lower interest rate stimulation. Ferguson’s six areas are competition, openness to scientific progress, property rights with the most advanced financial infrastructure, modern medicine, consumerism, and a strong work ethic (Ferguson, 2011). All of these areas should be the focus of targeted central banking efforts, for planting and nurturing the seeds of prosperity within these nations. Nations will not all need the same things. Some countries may require desalination plants and irrigation, while others may first need to focus on legislative changes to protect property rights and consumerism before they can begin. All of them should be focused on creating infrastructure to support business and industry, jobs, public services, improvements to education, healthcare, and many other benefits to the public.
Other Helpful Features.
The following beneficial features might be considered but are not inherently a part of the bank rate bifurcation model. Each nation’s central bank may have its own unique objectives, so the following features can be utilized à la carte. As a central bank is making decisions, these items are intended to be helpful and could be discussed when developing a plan for a CBDC system. They should be highly compatible with the proposed dual currency, dual interest rate model.
Currency swarm pegging. To maintain value stability, a well-designed CBDC should rely on multiple tactics for price fixing: Asset backing with free exchangeability for credit-worthy assets, algorithmic price pegging to the national fiat currency with exchangeability there as well, algorithmic price pegging to dozens of other swarm-pegged CBDCs with free exchangeability, and free arbitrage mobile apps. Market makers and others associated with traditional exchanges like to front-run transactions, which creates inefficiencies and expense (Berkman, et al., 2023, Gans & Holden, 2023). This paper proposes that decentralized blockchain exchange might be able to provide a low-cost solution and eliminate many of these inefficiencies and costs. A single peg might be more easily broken than a swarm of pegs.
Free arbitrage apps. As an additional safety net, software can be released as freeware that rewards investors to arbitrate pricing to the pegged value. Such free software can be released in multiple languages and send notices to investors when the CBDC is trading a few basis points above or below the par value of underlying assets. Apps like this already exist for Tether (USDT), such as those from Coin Rule, Trade Santa and USDT Trader. It should be noted that the release of arbitrage apps and digital pegging (technical tactics) alone are not enough to maintain price stability, because Tether has broken below its peg in the past. Fundamental tactics such as asset backing, and crowd psychology tactics described above, could further support price stability.
Wholesale CBDC only. Blockchain is under increasing cybersecurity threats because of rising value being stored there, and the nature of these threats has been studied (Schlatt, et al., 2023). If CBDCs are first implemented as a wholesale system using digital identities for all banks in the system, then only those who are allowed into the closed system (banks) could derive any possible benefit from the coins. This first phase of CBDC implementation would allow central banks to get things working properly and have time to finalize decisions on retail (second phase) CBDC systems. Another reason to delay the retail CBDC system is that software developers have a proclivity to produce novel solutions to problems, and these will probably include some sort of transactional insurance.
Blockchain dividends. While properly designed blockchain dividend capacity can make CBDCs upgradeable, dividend capability can also provide other benefits. An asset-backed CBDC that is appreciating in value relative to its counterpart fiat currency will have difficulty being pegged to that currency due to the diverging fundamental values. However, it can be pegged to that fiat currency if planned dividends (from anticipated asset value increases correlating to inflation) are passed as dividends to the wallets of CBDC holders. In that way, increasing the aggregated digital money supply relative to fiat inflation will dilute the CBDC value, from an assets-per-coin perspective. This will balance the CBDC and fiat money for parity pricing, while CBDC owners can continue to enjoy the benefits of their asset appreciation. This tactic should be phased out respectively if the CBDC is increasingly being used to back the fiat currency over a period.
Transactional taxes. A versatile and well-designed CBDC should also be able to collect taxes from each transaction. These taxes should be nominal transactional taxes, created as smart contracts with all coins so that the tax automatically goes into the treasury. This will create a system of tax collection for negligible costs. Tax evasion becomes impossible to do when using the CBDC. The tax can be constructed as a flat tax, progressive or graduated tax, and can be raised or lowered as legislators determine. These transactional blockchain taxes can be levied from the sender, the recipient, or both. If transactional buyer protection is being offered, the transactional tax can be a mechanism to charge for this service.
Metrics
Economists will be able to make assessments about the currency strength by evaluating the average interest rate of the two currencies, ratio of Stimulus Interest Rate Class money to Normal Interest Rate Class money, and the percentage points between them (rate class delta). If the proposed dual currency, dual interest model is successful, a larger interest rate class delta is predicted to have stronger correlation to desired outcomes. DeFi forex markets of the future might behave differently than today’s markets, due to the absence of human impedance to market efficiencies, but the usual metrics used by economists should apply to digital money just the same as fiat money.
Implementation and Transitioning
To begin the first steps of implementing this model, central bankers probably need to define their plan and secure governmental authorization to proceed with the issuance of a dual-currency system, to prevent legislators from fighting against perceived threats (Florida Senate, 2023). Because technology tends to become outdated, the central bank should ensure that the chosen blockchain can pass dividends of newer versions of the currency (as previously described) for seamless future technology upgrades. If the wholesale system is launched first, this will allow banks time to become comfortable with new systems.
This paragraph contains mostly anecdotal information gained from manipulating stock prices on Wall Street, which has been considered a “black art” with very little academic study. Anecdotal advice was contributed anonymously by secretive currency manipulators. As such, there are no references. The new asset-backed CBDC system should be launched with the old fiat system still in place, so that both are operating in parallel. An amount such as 3% of the nation’s M1 can be created and held in treasury. At this time the asset-backed CBDC (the Group 1b stablecoin) should be announced as now backing 3% of the nation’s fiat currency. With this, the forex markets might be expected to short the fiat. The following week, there should be an announcement that 6% of the nation’s fiat currency is now backed by Group 1b stablecoins. With this, forex traders may pause to reflect, reconsider, and search for more information about what is happening. Then the following week, an announcement could be made that now 9% of the nation’s fiat currency is backed by the new CBDC stablecoin, and that the nation intends to continue this effort until 100% of the national fiat is asset-backed. At this, the forex markets will probably stop shorting the fiat, and inflation will be substantially mitigated as asset-backing continues. If all news is given at once, the market will not absorb it. Instead, each bit of good news should be given slowly, and over time. One fact per week about the program is an adequate amount of information for the markets to digest and accept. As such, the central bank should announce with one of the weekly CBDC backing increases that the CBDC will be implemented with a new central bank bifurcation model to stimulate key sectors of the economy while controlling inflation in others. The stream of regular announcements will keep the currency in the spotlight and will encourage foreign investors to buy and hold the fiat, effectively reducing the “free float” of available fiat in the forex markets. This approach of weekly announcements should continue leaking information gradually to the public to gather increasing positive attention on both currencies, and on the key areas of infrastructure that are being built. The central bank should continue to comment on how these key areas are expected to influence GDP with their plan. After the initial good news, strategic sectorial stimulation, and growth, the banks can switch from providing revolutionary news to providing progress reports to continue their attempts to provide better information to the public. After banks have worked out any potential problems with their systems, the retail side may be added when banks are comfortable and ready.
The BIS offers several resources on the implementation of CBDCs on their websites, and private organizations may be available to make specific recommendations for optimal technology providers in light of each nation’s unique situation. Some organizations can provide recommended private contractors who are offering turn key CBDC systems, such as the Systemic Prosperity Institute.
This model can work well with three or more different interest rates by adding two different CBDCs to the national currency. The two CBDCs can be functionally identical for the public, and interchangeable in all manners except how they were created, with a small identifier built into the digital identifier of the blockchain. Exempli gratia, in the case of XYZ fiat currency, the central bank can offer a higher interest rate for XYZ fiat to curb inflation, a lower interest rate for digital XYZ-A for vital projects of infrastructure and national prosperity, and a moderate interest rate for digital XYZ-B for projects that are difficult to qualify.
In the proposed dual currency, dual interest rate model, the retail currency can be fiat, CBDC, or a combination of both. There should be a separation of the technology from the model, in order for the model to be able to be compatible with the upgrades and changes of future technology. Blockchain and distributed ledger technology in CBDC implementation should be expected to vary from nation to nation. This will allow each nation to utilize the retail systems favored by their citizens.
Potential Benefits and Rewards
There are some expected beneficial results from implementing this CBDC conceptual model. The money supply can be increased while inflation is curbed. The stability of the financial and banking system can be increased. Privacy concerns can be upheld while mitigating money laundering concerns. Cybersecurity can be upheld and given time to improve so that retain banking customers do not have their funds put at risk. Implementation costs would be very low.
Increasing money supply while mitigating inflation. Implementing this new central banking model built upon multiple interest rates should result in the targeted monetary stimulation of development related to the infrastructure of national prosperity, while simultaneously curbing inflation. If this is done in connection with a CBDC that is backed by a diversified portfolio of assets that are within the same nation and swarm-pegging system, and a policy of gradually implementing a policy of fiat backing (with CBDC stablecoin) over a suggested thirty three week period, Inflation can be completely halted temporarily. The best-case scenario for how long this system could be used to halt inflation should vary depending upon each nation’s own inflationary pressures and may be the subject of further research. Some nations might be able to enjoy halted inflation somewhere in the range of two years to two decades, and an indefinite length of time for being an effective means of repressing inflation. The more disciplined a nation is, when working together with its central bank with this model, the more effective they will together be in reaching targeted strategic objectives.
Financial stability. This model should help to increase financial stability, including helping to solidify the role and public perception of the many benefits of banks. The risk of bank disintermediation is mitigated because this model should increase GDP relative to M1 and do so while relieving inflationary pressure. If banks can provide the benefits of blockchain with the monetary security and fraud protection of fiat, this would increase the public demand for bank products, thereby increasing financial stability.
Privacy. This model should have no effect on privacy, as compared to the current fiat banking networks. When this model is implemented with digital identities, however, identity verification on wallets would prevent the anonymity of cryptocurrencies. It would therefore not be a suitable choice for illicit activities when used with digital identities.
Cybersecurity. Hackers pose a potential threat to cybersecurity. Anecdotal discussions were had with about five blockchain security engineers, which is an insufficient number to form a statistically significant consensus (Aczel, & Sounderpandian, 2019). With that in mind, these engineers all emphatically indicated that there is currently a very low level of trust in the “blockchain community,” towards banks. They stated that they believe the “black hat” (potentially malicious) hackers intend to wreak havoc on any draconian systems that are implemented. They reported that this is because these hackers see themselves as vigilantes— freedom fighters who oppose the introduction of financial fascism.
The proposed recommendations in this paper are intended to differentiate this system from such “draconian” appearances. If implemented properly, the proposed model could help to win the favor of would-be malicious hackers, the blockchain community, and the public in general. The old adage, “an ounce of prevention is worth a pound of cure,” may be applicable in this situation.
Implementation costs. Anticipated expenses to implement the model should be for a very reasonable up-front expense. When given a contract with a government and central bank, any contractor should be able to secure a loan to complete the work and deliver all for back-end compensation, paid via transactional taxes on the currency. In this way, a nation could offer to pay a nominal commitment fee to the developers to demonstrate that they are serious and offset their travel expenses, while politicians show constituents that the system to be offered is a turnkey solution with no expenses coming out of the national treasury. This will shift the risk of software development to software developers and leave the government free to focus governmental concerns. Because competition was listed as one of Ferguson’s precursors of affluence, the international private sector should be allowed to freely compete for all related contracting, and the contractors who are offering to take the bulk of their compensation at no expense to the national treasury should win. With the private sector able to participate in back-end transactional compensation and asset origination fees, they have a vested interest to ensure that everything is working smoothly and is well-received by the public and will be accepting of the fact that governments will not be responsible to pay for any on-going expenses related to maintaining the new CBDC system and its interest rate bifurcation model.
Potential Risks and Cautionary Concerns
The implications of this proposed model are discussed in this section. Potential benefits, drawbacks, and risks are suggested here, as well as predictions on how the proposed system aligns with or challenges current monetary policy practices. While this model provides new and useful tools for central bankers, it will not be a magical cure-all. It will not offer its potential benefits if it is not implemented correctly. Potential concerns for this model include political abuse, the weaponization of money, indecisiveness, over-consolidation, blockchain community hostility, and the iterative process.
Political abuse. This model is intended to be politically agnostic. Political parties may try to embrace this model as their own, for political gain. The potential is that governments could abuse the system in various manners. Governmental pressures may force central banks into granting lower interest rates for spending that is not actually related to the infrastructure that will stimulate national prosperity. Special interest groups could lobby for lower interest rates, adding confounding variables to dilute the effectiveness of the model. To mitigate the inevitable outcome of putting these decisions in the hands of politically biased individuals, politically neutral financial institutions such as central banks should be in full control of all banking decisions, especially interest rate allocations to different industrial sectors. Having banks make these decisions instead of governments is more likely to result in national growth (Scully, 1989).
The prosperity correlations of some projects in need of funding may be difficult to qualify. Should the manufacture of widgets be categorized as a stimulus rate or normal rate class? Rather than qualify these decisions objectively, politics being what it is, decisions may come to a vote. This is a bad idea because of the inclination of politicians to represent their constituents and special interest groups. In order for this model to work properly, these banking decisions should not be subject to a popular vote or the funding of political candidates. Central banks should step up and take control of financial stability in general because their objectives are closely aligned to this already, and because central banks have the power to do so (Blinder, 2010).
Weaponization of money. High interest rates could be used to target specific industries to satisfy the cries of special interest groups. This would probably start off with the most noble of intentions. Once started down that slippery slope of penalizing projects for this or that good cause, political cronyism can flourish. This is all the more reason that these controls should not be in the hands of the politically inclined.
The concern that this model could be applied with CBDCs using digital identities in a draconian manner is a legitimate concern. CBDCs that give spending control to others could be one of the worst forms of PR imaginable for central banks. The system could be attached to a social credit score. An all-encompassing social credit score is used by the Communist party in China as a means of control, which has been called “creepy” and a “draconian mass surveillance project” by critics (Shen, 2019). A social credit score that is attached to digital identities and a CBDC opens the door for governments to wield unprecedented amounts of control over the populace. If a central bank wants to avoid the very bad PR and appearance of ushering the next global fascist despot into power, it should expressly prohibit social credit scores. Central banks should go out of their way to clearly avoid being associated with anything that would fuel the fears of the blockchain community. Digital identities should be used exclusively by the banks that consumers choose, and for KYC purposes only.
Indecisiveness. Politicians and central bankers may be tempted to split central bank interest rates into multiple categories. Some of the projects that are difficult to qualify as needing a low or high interest rate could all too easily be classified as needing a median interest rate. A digital currency that is divided into multiple earmarks for 2 or more interest rate classifications could be necessary. Some may want to earmark dozens of different interest rate classifications, but it would be very easy to imagine how this could devolve into timidity where nearly every allocation is assigned a median interest rate.
Over-consolidation. When creating CBDCs, nations should not be too quick to unite under a common currency. While some would benefit from such a model, it would be more complex to ensure that each participating nation was receiving equal benefits from allocation. Nations with contrasting views on the proper application of the conceptual models of the Austrian school of economics might bear unequal loads and share unequal benefits. A proposed network of DeFi blockchain exchanges, all linking swarm-pegged CBDCs, could be the solution and negate the need for currency consolidation. This would allow nations to enjoy or suffer the consequences of their own fiscal policies but would allow for the nearly instantaneous cross-border commerce.
Blockchain community hostility. The blockchain community has been a wellspring of new technology and ideas, and the tight knit blockchain community has developed a nearly religious culture (Caradona, 2020). Despite the good things from this community, there has been a growing hostility towards banking in general, both from the anecdotally surveyed blockchain engineers as well as an informal look at the number of YouTube videos decrying banks and CBDCs. These videos are usually pushing various cryptocurrency schemes as would-be replacements. The blockchain engineers that were anecdotally surveyed, as described above, have reported that they do not want to be associated with CBDCs because they are “draconian” and want to implement “social credit scores” and other mechanisms to “take away freedom and privacy.”
Public relations. Banking industry leaders should be mindful to practice good public relations, and to distance themselves from individuals who do not practice good PR. An example of that is the YouTube video, “The SEC & Cryptocurrencies | Office Hours with Gary Gensler.” The video has had over 14,000 views, with about 1.0% of all viewers liking the video. To put it into perspective, the PewDiePie video entitled, “Can this video get 1,000,000 dislikes?” is one of the most disliked videos on YouTube, with about 1.5% of all viewers liking the video. Good intentions are not enough. The successful implementation of a CBDC must be “sold” to the public as beneficial, not force-fed like the prelude to a fascist takeover.
The public needs to be made aware of the facts, such as that easy access to credit makes economies strong. What percentage of the public are aware that our central banking system made things like college for the lower and middle classes a possibility? Or that prior to the advent of central banking, home loans were only available to people wealthy enough to afford a 50% down payment, and that student loans did not exist? There are so many beneficial aspects to our central banking system. In the same way that all businesses must cater to the wants and needs of the markets, banks cannot afford to be oblivious to the wants and needs of the blockchain community.
Iterative process. The development of these ideas is an iterative process. The approach should be refined based upon on-going research, feedback, and the evolving economic and financial landscape. This not only applies to the model presented in this paper, but to the blockchain itself. It is important to ensure that any CBDC that is used is fully upgradeable with robust dividend capabilities, because future improvements should be expected in all areas related to CBDC.
Additional Research Needed
There are some areas of additional research needed. More research is needed to translate these precursors of prosperity into highly specific lending guidelines for various nations. More research than is presently visible in the literature is probably needed for central bankers to be able to prevent the political weaponization of this model, and other CBDC models as well. What steps can legislators take to prevent digital identities and social credit scores from becoming Orwellian powers for a future fascist state to be able to lock-down and control spending of citizens? How can legislators keep CBDCs from being weaponized by governments to repress the people? Implementing this model as a wholesale CBDC is easiest because the retail side would not change much. Consumers would see very little disruption. Implementing a retail CBDC could be another matter, however. How can current bank AML and KYC processes be continued without interruption, or expedited and automated to be less intrusive to improve customer service excellence? Another area for additional research is a cost-benefit analysis to determine whether the potential benefits of using dual interest rates outweigh the costs and implementation challenges and risks. New AI programs that are heavy on APIs and self-improvement could manage the entire process, especially if they run multiple models and create a composite of all of their best findings. An AI that can monitor public sentiment and GDP metrics in real time could implement changes to monetary policy in real time as well. Pilot programs could be implemented in small to medium-sized nations that are dealing with a lot of inflation, or that want additional infrastructure development. Ghana has a strong GDP and high inflation (Woblesseh, et al., 2022, Anyars & Adabor, 2023). This, for example, could make Ghana a prime nation. Saudi Arabia needs business infrastructure to diversify its revenues while attracting strategic investors (Waheed, et al., 2023). Saudi Arabia could be an ideal nation for a pilot due these needs.
Conclusions
A dual-currency, dual interest rate central banking model can curb inflation while simultaneously stimulating key parts of the economy. This solves the either/or dilemma of banks being forced to choose to either stimulate the economy or curb inflation by either raising or lowering interest rates. The literature shows that there are some common denominators of national prosperity, including competitive business markets, advancements in technology and education, strong property rights, modern medicine, a consumer society, and a strong work ethic. Economic development and infrastructure investment theories emphasize the importance of developing critical infrastructure to be the backbone of economic growth. A lower CBDC interest rate for industry and infrastructure can promote prosperity and create jobs, while a higher fiat interest rate can address inflationary pressures, contributing to price stability. By using dual interest rates, central banks can adjust the monetary policy transmission mechanism to stimulate the economy without causing broad and general inflationary pressures. The dual monetary system facilitates interest rate compliance at the retail level and can help to gently introduce the new CBDC system to the public, increasing acceptance.
Several other ideas for implementing a successful CBDC are suggested, including that the CBDC should be backed by inflation resistant assets, such as federal land and natural resources to be developed. The CBDC should incrementally begin to back the national fiat currency over a period of a year of increases until parity is reached, because of the need to address crowd psychology market factors. The CBDC can ultimately be pegged to the fiat that it backs, and to other CBDCs backed by inflation-resistant assets. Mobile apps can encourage the public to help further support the pegs by exploiting arbitrage opportunities, further stabilizing the currency. CBDCs should initially adopt a wholesale CBDC system only for security and a smooth consumer transition, and to stall for more time for the retail CBDC infrastructure to develop. CBDCs can be upgradeable by using blockchain dividend compatibility so that replacement coins, to be developed in the future, can be dropped into the wallets of token holders. Dividend capability also allows stablecoin holders to receive “interest” in lieu of capital appreciation. Transactional taxes can be added with flexibility to the CBDC to increase net tax revenue. As such, gross taxes can be decreased due to the reduction of tax agency waste. Currency strength can be evaluated by economists examining the average interest rate and the percentage spread between the stimulus interest rate and normal interest rate.
Implementation of the dual currency, dual interest rate system should begin with governmental authorization. The fiat money system should be allowed to exist while the new CBDC system is being gradually implemented in parallel. Using the asset-backed CBDC to back the national fiat currency should be implemented gradually over a year or two to maintain currency stability and curb inflation. Doing this properly could have substantial mitigation effects on inflation. The dual system could be a triple or more interest rate and currency system by using digital identifiers in multiple CBDCs that appear to be identical to the public.
There are some potential benefits to this model. The money supply can be increased while inflation is curbed. Financial stability, security, and implementation costs are all considerations that weigh quite favorably for this model. When used properly this model can be received favorably by the blockchain community, including hackers and individuals who profess to be opposed to CBDCs.
There are some potential risks with this model. Interest rate allocations could be determined as political favors instead of objectively quantified rationale. Likewise, the political desire to please everyone could cause indecisiveness and water-down the effectiveness of the model. High interest rates could be used to target industries to satisfy special interest groups. The weaponization of money by political abuse could threaten the system. To address these risks central banks alone should be in charge of these bank decisions, not politicians. Special care needs to be taken to ensure that the blockchain markets are receptive to a CBDC. Optimizing the model will be an iterative process.
Additional research needed includes: How can one specifically qualify and define the sectors and projects that are the building blocks of societal affluence? How can legislators prevent digital identities and social credit scores from being exploited by would-be Orwellian dictators? How can banks and legislators keep money from being weaponized? How can bank AML and KYC processes be automated while improving customer service excellence? AI could answer and manage all of these questions. Pilot programs are needed in smaller nations.
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Taylor Moffitt of Halydean 