Monetary Policy with a Central Bank Digital Currency: The Short and the Long Term
75 Pages Posted: 3 Nov 2020
Date Written: September 1, 2020
We examine how the introduction of an interest-bearing central bank digital currency (CBDC) impacts bank activities and monetary policy. Depositors can switch from bank deposits to CBDC as a safe medium of exchange at any time. As banks face digital runs, either because depositors have a preference for CBDC or fear bank insolvency, monetary policy can use collateral requirements (and default penalties) to initially increase bankers' monitoring incentives. This leads to higher aggregate productivity. However, the mass of households holding CBDC will increase over time, causing additional liquidity risk for banks. After a certain period, monetary policy with tight collateral requirements generating liquidity risk for banks and exposing bankers to default penalties would render banking non-viable and prompt the central bank to abandon such policies. Under these circumstances, bankers' monitoring incentives will revert to low levels. Accordingly, a CBDC can at best yield short-term welfare gains.
Keywords: Central bank digital currency - Monetary policy - Banks - Deposits
JEL Classification: E42, E52, E58, G21, G28
Suggested Citation: Suggested Citation