Central bank digital currency increases financial inclusion, need not disintermediate banks

In this paper, David Andolfatto, an economist at the St Louis Fed, investigates the impact of central bank digital currency (CBDC) on banks in a model where the banking sector that is not perfectly competitive. There are two main results.

First, the introduction of interest-bearing CBDC increases financial inclusion and diminishes the demand for cash. Second, the introduction of interest-bearing CBDC need not disintermediate banks in any way and may, in fact, expand their depositor base if the added competition compels banks to raise their deposit rates.

The main adverse consequences are to be felt by banks in the form of lower monopoly profits. The fiscal authority too may have to bear the burden of a higher interest expense on its debt, but this may be a cost worth bearing if it leads to greater financial inclusion and stimulates household saving and capital formation.

These conclusions are the implications that follow from a highly abstract and provisional model and so should naturally be viewed with caution. The model abstracts from risk. There is no role for bank capital. There is no moral hazard. All of the debt is held in the banking sector. Only banks make loans, and so on.

On the other hand, the model features a bank sector with pricing power, banks that issue deposit liabilities redeemable in cash (and CBDC). The monetary authority follows an interest rate rule. The general equilibrium must be consistent with policy, and so on. The modeling framework is sufficiently simple to permit many interesting extensions worth exploring.

Read the full paper

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