Central Bank Digital Currency: Demand Shocks and Optimal Monetary Policy

TL;DR

This paper analyzes how a central bank digital currency (CBDC) affects household behavior, bank market power, and welfare, showing modest to significant welfare gains depending on policy optimization and market conditions.

Contribution

It introduces a New Keynesian model incorporating CBDC competition with bank deposits, analyzing its impact on monetary policy and welfare.

Findings

CBDC increases have a mildly expansionary effect.

Bank disintermediation remains modest despite deposit outflows.

Welfare gains are significant with optimized CBDC interest rate policies.

Abstract

We study the implications of a central bank digital currency (CBDC) for the transmission of household preference shocks and for welfare in a New Keynesian framework where the CBDC competes with bank deposits for household resources and banks have market power. We show that an increase in the perceived benefit of CBDC has a mildly expansionary effect, weakening bank market power and significantly reducing the deposit spread. As households economize on liquid asset holdings, they reduce both CBDC and deposit balances. However, the degree of bank disintermediation is low, as deposit outflows remain modest. We then examine the welfare implications of CBDC rate setting and find that, compared to a non-interest-bearing CBDC, the gains with standard coefficients for a CBDC interest rate Taylor rule are modest, but they become considerable when the coefficients are optimized. Welfare gains increase with the CBDC benefit, and the optimal policy responses vary with the banking market structure.