Central Bank Digital Currency: Demand Shocks and Optimal Monetary Policy
Hanfeng Chen, Maria Elena Filippin
TL;DR
This paper embeds a central bank digital currency (CBDC) into a New Keynesian framework where CBDC competes with bank deposits and banks have market power. It analyzes how a shock to the perceived CBDC benefit transmits through liquidity channels and how CBDC design—specifically, its interest rate policy—affects welfare. A key finding is that a positive CBDC-benefit shock mildly boosts activity and reduces deposit spreads, while overall bank disintermediation remains limited. The welfare gains from CBDC-based Taylor-rule policies are modest under standard coefficients but are substantial when policy rules are optimized, with the magnitude and direction depending on the structure of the banking sector and the perceived CBDC benefit.
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.