Payment System Externalities and the Role of Central Bank Digital Currency

36 Pages Posted: 3 Jan 2017 Last revised: 11 Jan 2020

See all articles by Christine A. Parlour

Christine A. Parlour

University of California, Berkeley - Finance Group

Uday Rajan

Stephen M. Ross School of Business, University of Michigan

Johan Walden

University of Lausanne; Swiss Finance Institute; University of California, Berkeley - Finance Group

Date Written: December 17, 2017

Abstract

We construct a model to examine how the payment processing role of banks affects their lending activity. In our model, banks operate in separate zones, and issue claims to entrepreneurs who purchase some inputs outside their own zone. Settling bank claims across zones ex post incurs a cost to a bank that is a net payer. We show that, in equilibrium, a liquidity externality arises when zones are sufficiently different in their outsourcing propensities. That is, a bank may restrict its own lending as a result of the need to hold liquidity against claims issued by another bank. The settlement cost dampens the size of this externality. We interpret wholesale Central Bank Digital Currency (CBDC) as a device that reduces the settlement cost, and show that it exacerbates lending inequalities across zones. Retail CBDC unambiguously increases lending in the model, and also increases the effectiveness of monetary policy implemented through reserves.

Keywords: Payment Systems, Banks, Central Bank Digital Currency

JEL Classification: G21, E51

Suggested Citation

Parlour, Christine A. and Rajan, Uday and Walden, Johan, Payment System Externalities and the Role of Central Bank Digital Currency (December 17, 2017). Ross School of Business Paper No. 1337. Available at SSRN: https://ssrn.com/abstract=2892150 or http://dx.doi.org/10.2139/ssrn.2892150

Christine A. Parlour (Contact Author)

University of California, Berkeley - Finance Group ( email )

Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States
510-643-9391 (Phone)

Uday Rajan

Stephen M. Ross School of Business, University of Michigan ( email )

701 Tappan Street
Ann Arbor, MI 48109
United States
734-764-2310 (Phone)

HOME PAGE: http://webuser.bus.umich.edu/urajan

Johan Walden

University of Lausanne

Quartier Chambronne
Lausanne, Vaud CH-1015
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

University of California, Berkeley - Finance Group ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
(510) 643-0547 (Phone)

HOME PAGE: http://www.haas.berkeley.edu/faculty/walden.html

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