The economics of central bank digital currency
Toni Ahnert, Katrin Assenmacher, The economics of central bank digital
Peter Hoffmann, Agnese Leonello,
Cyril Monnet, Davide Porcellacchia currency
Disclaimer: This paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB.
Discussion papers are research-based papers on policy relevant topics. They are singled out from standard Working Papers in that they offer a broader and more balanced perspective. While being partly based on original research, they place the analysis in the wider context of the literature on the topic. They also consider explicitly the policy perspective, with a view to develop a number of key policy messages. Their format offers the advantage that alternative analyses and perspectives can be combined, including theoretical and empirical work.
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This paper provides a structured overview of the burgeoning literature on the economics of CBDC. We document the economic forces that shape the rise of digital money and review motives for the issuance of CBDC. We then study the implications for the financial system and discuss of a number of policy issues and challenges. While the academic literature broadly echoes policy makers’ concerns about bank disintermediation and financial stability risks, it also provides conditions under which such adverse effects may not materialize. We also point to several knowledge gaps that merit further work, including data privacy and the study of end-user preferences for attributes of digital payment methods.
JEL Codes: E41, E42, E51, E52, E58, G21
Keywords: Central Bank Digital Currency, Digital Money, Payments, Monetary Policy, Financial
Currently, all major central banks around the world are exploring the case for introducing central bank digital currency (CBDC). Policy makers’ interest has been fueled by the secular decline in the use of cash and the proliferation of digital payments, which pose significant challenges to the status quo of the current financial system. Unsurprisingly, the policy debate has sparked interest in the academic community and led to a rapid growth of research on the wider implications of a CBDC introduction.
This paper provides a structured overview of the burgeoning literature on the economics of CBDC. It reviews the developments that have led to the rise of digital money, followed by a synthesis of the various economic motives that have been put forward for the introduction of a CBDC. We point out how network externalities that are present in the use of a medium of exchange are reinforced by the access to data that arise from trading on large platforms. These network externalities could lead to a dominance of BigTech companies in the payments market, providing a motivation for central banks to introduce CBDC.
The paper then proceeds to review the potential implications for two key themes of interest for the central banking community, namely monetary policy and financial stability. We argue that public digital money in form of a CBDC could replace banknotes as the monetary anchor of today’s two-layer monetary system and help retaining monetary sovereignty if global stablecoins became widely used. A much-debated issue is privacy in payments, where we argue that market forces on their own are unlikely to lead to an optimal degree of privacy. We then go on to explore the interactions of a CBDC with monetary policy transmission and implementation. The main implications arise from the substitution of bank deposits for CBDC and the resulting changes in banks’ funding structure. When issuing a CBDC, central banks need also to be aware of potential consequences for the size and structure of their own balance sheets. Regarding financial stability, a CBDC could on the one hand increase the probability of a bank run but might on the other hand incentivise banks to offer more attractive deposits, giving rise to a potentially non-linear relationship between CBDC remuneration and bank stability.
The remainder of the paper contains a discussion of key policy issues and challenges such as regulation and incentives for adoption of a CBDC, and highlights a number of takeaways that emerge from the review of the literature.
Importantly, the paper focuses on the topic of a retail CBDC” accessible to citizens and non-financial firms. It does not touch upon a parallel debate about wholesale CBDC” intended for use by financial intermediaries.
Traditionally, interest in the economics of money and payments has been largely confined to a narrow circle of experts in central banking, academia, and the financial industry. This has changed dramatically over the past 15 years or so, as technological innovation is disrupting the market for payments at an unprecedented scale, and the resulting changes are becoming tangible in citizens’ everyday lives. Strong growth in e-commerce has led to a decline in the use of cash and increased demand for electronic payments. Technology-driven start-ups (Fintech”) and large digital platforms (BigTech”) are increasingly pushing into a market traditionally dominated by banks and credit card companies. At the same time, the development of distributed ledger technology (DLT) enables the decentralized settlement of electronic transactions, which has spurred the creation of fiat cryptocurrencies and stablecoins.
These developments have inspired central bankers to explore the merits of introducing a digital version of cash: central bank digital currency (CBDC). Notably, this debate has intensified considerably in recent years as policy makers have become unsettled by prospects for abrupt and potentially irreversible changes to the financial system due to the existence of strong network effects in both payments and digital services. Although ultimately not realized, the initial Libra proposal by Facebook (now Meta) was widely perceived as a significant wake-up call and led to an intensification of research efforts throughout the central banking community. According to a recent survey, 90% of 81 respondent central banks were actively investigating the potential for a CBDC at the end of 2021 (Kosse and Mattei, 2022).
This paper provides a structured overview of the burgeoning literature on the economics of CBDC. It starts out with a review of the underlying economic drivers of the rise of digital money, namely the digitalisation of economic activity and, consequently, payments. We then discuss how these developments give rise to concerns about the role of public money as anchor for the two-layer monetary system, monetary sovereignty, privacy in payments, and other frictions that motivate central banks to consider the issuance of CBDC.
Next, we study the implications of a CBDC introduction for the financial system. We first consider potential changes to the transmission and implementation of monetary policy, with a particular focus on the role of banks due to their central role in money creation and credit supply. We then discuss the consequences for financial stability, where we distinguish between effects affecting the asset and liability sides of intermediaries’ balance sheets, as well as the implications for financial stabilization policies. For both monetary policy and financial stability, we also discuss the role of proposed safeguards in the CBDC design that aim to mitigate potential adverse effects.
The last section discusses several policy issues and challenges. First, we ask whether some of the key objectives that CBDCs aim to address could also be achieved through regulatory action. Then, we consider challenges related to end-user adoption (e.g. by consumers and merchants) on the basis of a pre-existing literature on the economics of payment instrument choice. And finally, we point towards several political economy issues.
In the conclusion, we highlight a few selected insights that arise from our review of the literature.
While academics acknowledge policy makers’ concerns about the potentially adverse effects of a
CBDC issuance on bank lending and financial stability, they also point to mitigating forces. For example, credit supply may ultimately benefit from more competitive deposit markets. Similarly, more attractive deposit contracts could help limit the risk of bank runs. We also point to promising avenues for future research. Privacy in payments is a complex issue waiting to be explored further. And the proliferation of electronic payments raises interesting questions concerning the preferences of endusers over the various attributes offered by new forms of digital money.
Our paper focuses on the economics of retail CBDC”, a digital central bank liability that is accessible to citizens and non-financial firms. We do not touch upon a parallel debate about wholesale CBDC” intended for use by financial intermediaries because it will entail a less significant change to the status quo of the financial system. While we discuss technological innovations such as distributed ledger technology and the relationship between CBDC and stablecoins, our paper largely steers clear of the topics of cryptocurrencies and decentralized finance (DeFi”).
2 Digitalisation in business and payments
This section provides an overview of the key drivers that have led to the debate about the potential introduction of central bank digital currency. We first review how the ongoing digitalisation is reshaping the economy, and then discuss the rise of digital money.
2.1 The economy in the information age
The digitalization of the economy is progressing at break-neck speed. Firms are dramatically increasing investment into information and communication technologies (ICT) to reap the associated productivity gains (Figure 1A). At the same time, the distribution of goods and services is steadily shifting towards online channels (Figure 1B).
Panel A: ICT usage Panel B: E-commerce
Figure 1. The left panel (A) depicts various measures of ICT usage for the euro area over time. Computer” refers to the percentage of employees that use a personal computer at work. ERP software” denotes the share of firms that use
Enterprise Resource Planning software. Cloud” refers to the percentage of firms using cloud computing services. Countries: DE, FI, FR, GR, IE, IT, LU, NL, PT, ES. Source: OECD. The right panel (B) illustrates the growth in e-commerce for the euro area over time. Online purchases” represents the percentage of for individuals that have purchased at least one item online over the last 12 months. Online sales” refers to the share of firms with online sales. Countries: AT, BE, DE, EE, FI, FR, IE, GR, ES, IT, CY, LV, LT, LU, MT, NL, PT, SI, SK. Source: Eurostat. All series are aggregated using GDP-weights.
The ongoing digitalization is leading to rapid changes in the overall structure of the economy. Two driving forces stand out: digital platforms as dominant business model, and an increasing role for intangible inputs such as data and software. While both promise significant efficiency gains, concerns are mounting that they also give rise to market power and enable anti-competitive practices.
Digital platforms such as Google, Amazon, or Facebook are the signature business model of the digital economy. They operate as two-sided markets, which entails two key features (see Rysman, 2009). First, they intermediate transactions between two groups of agents. Second, a network externality is present: the decisions of each group of agents affect those of the agents on the other side of the platform. For example, sellers will find an online marketplace more attractive if more buyers are present, and vice versa.
Network externalities are a source of market power and thus play a key role for platform pricing and competition.3 Platforms aim to strengthen network externalities by creating closed ecosystem (socalled walled gardens”) with the aim of locking in one side of the market, which enables them to charge monopoly prices to the other side. In the extreme, this can give rise to a winner-takes-it-all outcome with a single dominant platform in a particular market segment.
Beyond the dominance of digital platforms, an increased role for intangible inputs such as data and software are a defining feature of the digital economy. This gives rise to significant scale economies with increased fixed costs and reduced marginal costs, which favors large firms (Farboodi et al., 2019; Farboodi and Veldkamp, 2021). The resulting shift in the economy’s cost structure leads to a competitive edge for early technology adopters. While this boosts productivity in the short run, it deters entry by new firms and thus leads to lower growth in the long run (De Ridder, 2021).
Unlike traditional inputs, data is non-rival: It can be used multiple times, or by multiple parties (Jones and Tonetti, 2020). Accordingly, a broad use of data on consumer preferences promises large social gains through more efficient matching and better goods and services. However, private incentives typically lead to data hoarding as firms aim to exert market power and fend off competitors. Since network externalities and private access to data can be mutually reinforcing, such concerns become particularly acute in the case of digital platforms.
Empirical work supports the overall narrative of increasing concentration and market power. The evidence shows that mark-ups are rising (De Loecker et al., 2020) and a handful of superstar firms” have emerged as dominant (
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