We analyze retail central bank digital currency (CBDC) in a two-tier monetary system with bank deposit market power and externalities from liquidity transformation. Resource costs of liquidity provision determine the optimal monetary architecture and modified Friedman (1969) rules the optimal monetary policy. Optimal interest rates on reserves and CBDC differ. A calibration for the U.S. suggests a weak case for CBDC in the baseline but a much clearer case when too-big-to-fail banks, tax distortions or instrument restrictions are present. Depending on central bank choices CBDC raises U.S. bank funding costs by up to 1.5 percent of GDP.
We analyze policy in a two-tiered monetary system. Noncompetitive banks issue deposits while the central bank issues reserves and a retail CBDC. Monies differ with respect to operating costs and liquidity. We map the framework into a baseline business cycle model with “pseudo wedges” and derive optimal policy rules: Spreads satisfy modified Friedman rules and deposits must be taxed or subsidized. We generalize the Brunnermeier and Niepelt (2019) result on the macro irrelevance of CBDC but show that a deposit based payment system requires higher taxes. The model implies annual implicit subsidies to U.S. banks of up to 0.8 percent of GDP during the period 1999-2017.
Neue Zürcher Zeitung, February 20, 2015. PDF, HTML. Ökonomenstimme, February 24, 2015. HTML.
Allowing the general public to hold reserves at the central bank could help reduce the risk of bank runs and the negative consequences of deposit insurance.
It would end the need to accept bank deposits as means of payment although they are not legal tender; this need arises due to prohibitions on cash payments, for tax reasons.
But it could also have negative consequences: Money and credit creation by banks would be undermined, with social costs and benefits.
Price stability and financial stability could be threatened during the transition period.
More technical questions would have to be addressed as well: They concern the payment system or the conduct of monetary policy.
Proposals to go further and to abolish cash are not convincing. One suggested benefit—more leeway for monetary policy makers—is over estimated: Negative rates can also be engineered (effectively) through fiscal policy, and they can fully be implemented with a flexible exchange rate between reserves and cash.
Another suggested benefit—better monitoring of tax dodgers and criminals—is also overrated; the fixed cost to circumvent the measure would deter minor illegal activity but not major one.
But abolishing cash would have severe negative consequences for privacy and could negatively affect financial literacy.
Enforcing an abolishment of cash would be difficult. In a free society, any reform to the monetary system is constrained by the requirement that money must remain attractive for its users.