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Should Central Banks Issue Digital Currency?

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Abstract

We study how the introduction of a central bank-issued digital currency affects interest rates, the level of economic activity, and welfare in an environment where both central bank money and private bank deposits are used in exchange. Banks in our model are financially constrained, and the liquidity premium on bank deposits affects the level of aggregate investment. We study the optimal design of a digital currency in this setting, including whether it should pay interest and how widely it should circulate. We highlight an important policy tradeoff: while a digital currency tends to promote efficiency in exchange, it can also crowd out bank deposits, raise banks' funding costs, and decrease investment. Despite these effects, introducing a central bank digital currency often raises welfare.

Suggested Citation

  • Todd Keister & Daniel R. Sanches, 2019. "Should Central Banks Issue Digital Currency?," Working Papers 19-26, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:19-26
    DOI: 10.21799/frbp.wp.2019.26
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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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