Discussion paper

DP15322 Monetary Policy with a Central Bank Digital Currency: The Short and the Long Term

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.

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Citation

Böser, F and H Gersbach (2020), ‘DP15322 Monetary Policy with a Central Bank Digital Currency: The Short and the Long Term‘, CEPR Discussion Paper No. 15322. CEPR Press, Paris & London. https://cepr.org/publications/dp15322