Central Bank currencies grow in acceptance

As payment systems rapidly evolve, new analysis of Central Bank strategies suggests a future path for new digital currencies, according to the latest research from the IMF.

"Developments in digital networks and technology and the increasing share of internet-based retailing have created the demand and technological space for peer-to-peer digital transactions that have the potential to radically change payment and financial intermediation systems," Itai Agur, author of recent IMF working paper on the topic states. 

While most central banks have been pondering whether and how to adapt, some are exploring the idea of issuing central bank digital currency (CBDC) - a new type of fiat money that expands digital access to central bank reserves to the public at large, instead of restricting it to commercial banks.

A CBDC would combine the digital nature of deposits with the peer-to-peer transactions use of cash. But the topic raises a number of core questions:

  • Would it resemble deposits by coming in the form of an account at the central bank, or would it come closer to cash, materializing as a digital token?
  • Would it pay interest rates like a bank deposit, or would its nominal return be fixed at naught, like cash?

Agur and co-authors build a theoretical framework geared at analyzing the relationship between CBDC design, the demand for money types, and financial intermediation. Swings in the usage of payment instruments become particularly disruptive in the presence of network effects. For example, with declining cash use, banks may cut back on ATMs or shops may refuse to accept cash, a process currently underway in Sweden.

Because of such network effects, payment instruments may disappear when their use falls below a critical threshold, and the successful introduction of a CBDC could risk tipping the balance. Network effects are a critical feature of the model in this paper. Our starting point is a (static) economy with banks, firms and households. In this economy, banks collect deposits, extend credit to firms, and create social value in doing so: firms’ projects are worth less if they cannot receive bank loans.3 Both banks and firms engage in perfect competition.

"CBDC can be designed with attributes similar to cash or deposits, and can be interest-bearing: a CBDC that closely competes with deposits depresses bank credit and output, while a cash-like CBDC may lead to the disappearance of cash. Then, the optimal CBDC design trades off bank intermediation against the social value of maintaining diverse payment instruments. When network effects matter, an interest-bearing CBDC alleviates the central bank's tradeoff," Agur comments.

Read this working paper in full: http://www.imf.org/external/pubs/cat/longres.aspx?sk=48739

IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. For a full list of IMF Publications visit: https://www.imf.org/en/Publications


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