Implications of central bank backed digital currencies (crypto currencies) on monetary policy, financial stability and balance sheets

An exploratory scenario analysis

Master's Thesis , 2018 , 115 Pages , Grade: 1,0

Economics - Finance

Inspired by the recent publication of various Central Banks that study the issuance of their own versions of digital currencies, this paper aims at identifying the implications of such a central bank issued digital currency on monetary policy, financial stability and non-bank private sector, central bank and commercial bank balance sheet. It does so by conducting a scenario analysis, where each scenario specifies a distinct form of how a central bank issued digital currency could be introduced and how the resulting implications on the spheres of interest might change as a consequence.

The results of this scenario analysis propose that in either implementation mode a CBDC generally provides a positive effect on both financial stability and monetary policy. The degree of the advantageous effect is, however, not only dependent on the implementation scenario, but also on the behaviour of the central banks, the commercial banks and the general public. In terms of balance sheets, this paper identified major changes. The results and implications that have been derived are based on literature, an expert interview and previous research conducted by other central banks and notable scholars.

Based on the implications stemming from the four investigated scenarios, this paper evaluates these implications from a perspective of the New Currency School and Banking School. All in all, since this paper sees a central bank backed digital currency as a potential catalyst for a substantial change of the current monetary system, it provides scenarios and theories that challenge the status quo.

Inhaltsverzeichnis (Table of Contents)

• 1. Introduction
• 2. The era of digital currencies
• 2.1. Cryptocurrencies, Digital Currencies, Virtual Currencies and Electronic Money
• 2.2. Central-Bank backed crypto-currency (CBDC)
• 2.3. Value versus account-based CBDC
• 2.4. Current state of research on CBDC amongst world's central banks
• 2.5. Types of money in the current economic system of the Euro Area
• 2.6. Summary
• 3. Methodology
• 3.1. Derivation of the four scenarios
• 3.2. Guiding thread of the paper
• 3.3. Delimitations of the study
• 3.3.2. Constraints regarding the two technological implementation options of a CBDC
• 3.4. Expert interviews
• 3.5. Summary
• 4. Status quo: Monetary policy and the banking system in the Euro Area
• 4.1. Monetary policy of the European Central bank
• 4.1.1. Monetary Policy in the Euro Zone
• 4.1.2. Current Monetary Policy Tools
• 4.1.3. Zero lower bound (ZLB) and the post crisis dilemma of ECB
• 4.2. Financial Stability: Commercial banks & the fractional reserve banking system (FRB)
• 4.2.1. The split-circuit of the two-tier money and banking structure
• 4.3. Stylized balance sheets
• 4.4. Summary
• 5. Theoretical concepts and literature review
• 5.1. Dialectic of money
• 5.2. Agency- theory: Moral Hazard of banks
• 5.3. Currency vs. Banking School
• 5.3.1. New Currency School
• 5.3.2. Banking school
• 5.3.3. Comparison of key arguments from Currency- and Banking School
• 5.4. Sovereign money model
• 5.6. Summary
• 6. Implications of a CBDC on monetary policy, financial stability & balance sheets
• 6.1. Scenario 1 - CBDC as a complementary to cash and bank money
• 6.1.1. Monetary Policy
• 6.1.2. Financial Stability
• 6.1.3. Balance Sheets
• 6.2. Scenario 2 - CBDC as replacement for cash and complementary bank money
• 6.2.1. Monetary Policy
• 6.2.1.1 Monetary Policy Implications under a CBDC with a constant nominal value (non-interest bearing)
• 6.2.1.2 Monetary Policy Implications under an interest-bearing CBDC
• 6.2.2. Financial stability
• 6.2.3. Balance Sheets
• 6.3. Scenario 3 & 4 - CBDC as replacement for bank money and complementary/ replacement for cash
• 6.3.1. Monetary Policy
• 6.3.2. Financial stability
• 6.3.3. Balance Sheets
• 6.4. Summary of results
• 7. Discussion of scenarios in two schools: Currency vs. Banking School
• 7.1. Classification of Scenario 1
• 7.2. Classification of Scenario 2
• 7.3. Classification of Scenario 3 & 4
• 7.4. Summary
• 8. Discussion and suggestion for further research

Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)

This paper investigates the potential implications of a central bank-issued digital currency (CBDC) on monetary policy, financial stability, and the balance sheets of non-bank private sector, central bank, and commercial banks. The research employs a scenario analysis to explore different CBDC implementation models and their potential impact on these key areas.

• The impact of a CBDC on monetary policy effectiveness and the role of central banks
• Potential implications for financial stability and the management of systemic risk
• The effects of a CBDC on the balance sheets of various stakeholders, including commercial banks, central banks, and the non-bank private sector
• The role of technological advancements in shaping the future of monetary systems
• The potential impact of a CBDC on the existing economic and financial order

Zusammenfassung der Kapitel (Chapter Summaries)

• Chapter 1 provides an introduction to the research topic, highlighting the growing interest in central bank digital currencies and the potential implications for monetary policy and financial stability.
• Chapter 2 explores the different types of digital currencies, including cryptocurrencies, virtual currencies, and electronic money. It examines the concept of central bank-backed digital currencies (CBDCs) and their potential advantages and disadvantages.
• Chapter 3 outlines the methodology used in this paper, including the derivation of four scenarios for CBDC implementation and the use of expert interviews to gather insights from key stakeholders.
• Chapter 4 presents an overview of the current monetary policy framework and the banking system in the Euro Area, focusing on the roles of the European Central Bank and commercial banks in maintaining financial stability.
• Chapter 5 reviews relevant theoretical concepts and literature, exploring the dialectic of money, agency theory, and the Currency vs. Banking school debates. It also examines the sovereign money model and its potential relevance to the CBDC discussion.
• Chapter 6 analyzes the potential implications of a CBDC on monetary policy, financial stability, and balance sheets across the four scenarios. It investigates the potential impact of each scenario on the central bank, commercial banks, and the non-bank private sector.

Schlüsselwörter (Keywords)

This study focuses on the implications of a central bank-backed digital currency (CBDC) on monetary policy, financial stability, and balance sheets. It delves into the key themes of monetary policy effectiveness, financial stability management, and the role of commercial banks in the evolving monetary system. Additionally, the paper explores technological advancements in digital currency implementation and the potential impact on the existing economic and financial order.

Frequently Asked Questions

What is a CBDC?

A Central Bank Digital Currency (CBDC) is a digital version of a country's fiat currency, issued and backed directly by the central bank.

How would a CBDC affect monetary policy?

The research suggests that a CBDC could improve monetary policy effectiveness, potentially allowing for better interest rate transmission and addressing the "zero lower bound" dilemma.

What are the risks to financial stability?

Risks depend on implementation; for instance, a CBDC could lead to "digital bank runs" if the public shifts large amounts of money from commercial banks to central bank accounts during a crisis.

What is the difference between value-based and account-based CBDC?

Value-based CBDCs function like digital cash (anonymous/token-based), while account-based systems require identity verification and are managed through accounts at the central bank.

What role do commercial banks play in a CBDC scenario?

Commercial bank balance sheets would undergo major changes, as a CBDC might compete with traditional bank deposits, forcing banks to find alternative funding sources.

• College: Copenhagen Business School
• Grade: 1,0
• Authors: Marko Francesevic (Author), Marco Schuster (Author)
• Publication Year: 2018
• Pages: 115
• Catalog Number: V463942
• ISBN (eBook): 9783668928886
• ISBN (Book): 9783668928893
• Language: English
• Tags: cryptocurrency, digital currency, central bank, monetary policy, european central bank, key interest rate, negative interest rate, financial stability, monetary theory, ageny theory, Fractional reserve banking system, souvereign money, positive money, New Currency School, Banking School, Types of money