Central Bank Digital Currency: When Price and Bank Stability Collide

This paper shows the existence of a central bank trilemma. When a central bank is involved in financial intermediation, either directly through a central bank digital currency (CBDC) or indirectly through other policy instruments, it can only achieve at most two of three objectives: a socially eÿcient allocation, financial stability (i.e., absence of runs), and price stability. In particular, a commitment to price stability can cause a run on the central bank. Implementation of the socially optimal allocation requires a commitment to inflation. We illustrate this idea through a nominal version of the Diamond and Dybvig (1983) model. Our perspective may be particularly appropriate when CBDCs are introduced on a wide scale.

Keywords: bank runs, CBDC, central bank digital currency, currency crises, financial intermediation, inflation targeting, monetary policy, spending runs

JEL Classification: E58, G21

Suggested Citation: Suggested Citation

Fernández-Villaverde, Jesús and Schilling, Linda and Uhlig, Harald, Central Bank Digital Currency: When Price and Bank Stability Collide (January, 2024). ECB Working Paper No. 2024/2888, Available at SSRN: https://ssrn.com/abstract=4695945 or http://dx.doi.org/10.2139/ssrn.4695945