VoxEU Column Monetary Policy

Central bank digital currency: Why it matters and why not

The potential benefits and risks of digital central bank money for use by the general public have been widely debated. This column looks at one aspect that has been somewhat overlooked – the consequences of substituting outside for inside money. ‘Reserves for all’ could increase the incentive to extend credit but might undermine political support for implicit financial assistance to banks. However, the effects need not be disruptive. 

Far into the 20th century, central banks commonly offered accounts not only to a select group of financial institutions but also to non-banks. This liberal approach has given way to a monetary arrangement where access to electronic central bank money(‘reserves’) is generally restricted to banks. When households or non-financial firms pay electronically, they use privately issued money (e.g. bank deposits), not central bank money.

This arrangement is increasingly being questioned. Following Tobin (1985), many have proposed a form of digital central bank money for use by the general public– ‘reserves for all’, or RFA – and have debated potential benefits and risks.1 The discussions typically lack a model, and fundamental economic issues often remain obscure while questions regarding technical implementation (e.g. crypto or not) receive a lot of emphasis. The key macroeconomic aspects of central bank digital currency– namely, the consequences of substituting outside for inside money – remain under researched.


In a recent paper, I propose an equivalence result to help shed light on theseconsequences (Niepelt 2018). The proposition is in the spirit of Modigliani and Miller (1958), Barro (1974), Wallace (1981), or Chamley and Polemarchakis (1984). Its purpose is to provide a benchmark, not the most realistic description, in order to identify key conditions for equivalence, and thus potential sources of non-equivalence. The macroeconomic perspective I adopt emphasises balance sheets and budget constraints. It contrasts with partial equilibrium intuitions inspired by models in the tradition of Diamond and Dybvig (1983) which underlie many arguments in the debate.

The basic intuition for the result is as follows. Inside money serves as a store of value and a means of payment. RFA can equivalently serve these functions if they are accompanied by fiscal interventions. Inside and outside money thus can be substituted against each other, subject to appropriate fiscal interventions, without macroeconomic consequences.

Store of value

Whether the central bank issues outside money or the banking sector inside money is irrelevant for aggregate wealth. It might, however, be relevant from a distributional point of view, for example because inside and outside money have different payment characteristics. But distributive implications can be sterilized by appropriate transfers.

What about ‘crowding out’? Inside money is both a private sector asset and liability and therefore does not increase private sector wealth. Outside money, in contrast, constitutes a private sector asset and public sector liability. Does this imply that outside money absorbs private savings that otherwise would have funded physical investment? No, becausetaxpayers ultimately are responsible for covering public deficits, public debt (including outside money) does not increase private sector net worth (Barro 1974). At the aggregate level, the crowding out argument is therefore invalid unless it relies on fiscal myopia. At the disaggregated level, crowding out certainly may occur when issuance of outside money or other forms of public debt redistribute tax burdens across groups with different propensities to save. But this redistribution can be offset by appropriate transfers.

Means of payment

For outside money to replace inside money as a means of payment, banks could sell a corresponding amount of assets to the central bank in exchange for reserves. In effect, banks would replace loans or securities on their balance sheets with reserves and a share of their deposits currently used for payments would be ‘backed’ by these reserves – a situation akin to having non-banks use reserves as means of payment. The extent of ‘maturity transformation’ in the banking sector would be reduced.

This would again have distributive implications because banks would earn a lower spread on their assets net of liabilities. To offset these implications, the central bank could refund to banks their lost seignorage profits such that, on net, banks' profit streams would remain unchanged. The modified balance sheet structure of banks and the compensating transfers from the central bank would render explicit what is implicit in the current monetary system: the lender of last resort (LOLR) guarantee provided by the central bank, and the value of that guarantee.2

The process of credit extension would not change. Banks would continue to screen and select projects that receive financing before selling the loans on to the central bank or using them as collateral to obtain central bank loans.


The equivalence proposition relies on a series of conditions. Probably the most important ones relate to bank and central bank incentives.


Changes in the balance sheet structure of banks could affect the incentives to exert screening and monitoring efforts. How strong this effect would be, and whether it would result in stronger or weaker incentives, is unclear as this would depend on the regulatory framework; after all, depositors do not currently play a meaningful monitoring role but mostly rely on the government. If banks reduced their efforts and adopted an originate-to-distribute business model, then this could work in the direction of relaxing credit standards and originating morerather than fewer loans – just the opposite of what many commentators fear.

Central bank

Once an equivalent change of fiscal-monetary policy renders the implicit LOLR guarantees explicit, the political support for them would likely change – the equivalent fiscal-monetary policy would no longer constitute an equilibrium policy. Whether the support would rise or fall depends, among other factors, on the degree of competition in the banking sector.

Time consistency would leave its mark as well (Kydland and Prescott 1977). Fiscal-monetary policy in the current monetary regime is time consistent, by definition. In a regime with less inside money, the ex-post incentive compatibility constraints of policymakers would change because the state variables determining their choice sets evolved in different ways. What lies at the root of the ex-post incentive constraints in the current regime – namely, that private money creation puts the central bank at a second-mover disadvantage and effectively forces it to serve as LOLR during liquidity crises – could change when less inside money is issued and transfers become explicit.

Another potential source of non-equivalence concerns asset management. Under the assumptions underlying the equivalence proposition, the central bank would not directly intervene in the process of credit allocation but refinance banks at the same conditions as it currently does as a LOLR. But whether this would be politically sustainable is questionable. Credit extension could rather become more politicised and this might change investment.


The proposal to issue digital central bank money for use by the general public enjoys surprisingly strong support among finance practitioners but equally often faces scepticism, particularly in central bank circles. A typical line of argument put forward by the sceptics emphasises that the traditional approach has served us well, and that a change of regime could have disruptive effects.

But the ‘traditional approach’ has evolved over the years and will continue to evolve; and in the absence of a clear counterfactual, it is difficult to assess whether it really has worked ‘well’. Moreover, from a macroeconomic point of view, RFA need not have disruptive effects and if it does have such effects, they might well occur in other areas or have different signs than what is commonly suggested. For example, RFA could increase the incentive to extend credit but might undermine the political support for implicit financial assistance to banks. 


Barro, R J (1974), “Are government bonds net wealth?”, Journal of Political Economy 82(6): 1095—1117.

Chamley, C and H Polemarchakis (1984), “Assets, general equilibrium and the neutrality of money”, Review of Economic Studies 51(1): 129—138.

Diamond, D W and P H Dybvig (1983), “Bank runs, deposit insurance, and liquidity”, Journal of Political Economy 91(3): 401—419.

Kydland, F E and E C Prescott (1977), “Rules rather than discretion: The inconsistency of optimal plans”, Journal of Political Economy 85(3): 473—491. 

Modigliani, F and M H Miller (1958), “The cost of capital, corporation finance and the theory of investment”, American Economic Review 48(3): 261—297.

Niepelt, D (2018), “Reserves for All? Central bank digital currency, deposits, and their (non)-equivalence”, CEPR Discussion Paper 13065. 

Tobin, J (1985), “Financial innovation and deregulation in perspective”, Bank of Japan Monetary and Economic Studies 3(2): 19—29.

Wallace, N (1981), “A Modigliani-Miller theorem for open-market operations”, American Economic Review 71(3): 267—274.


[1] See Niepelt (2018) for an overview over contributions to this debate as well as to related discussions on narrow banking and the future of cash. 

[2] Again, there are parallels to public debt whose dominant component in many countries is implicit.

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