For our analysis and, ultimately, as a starting point for thinking about these issues, we assume that this delegation works without friction: relying on investment banks is just as good for the central bank as having the expertise to invest in these long-term projects on its own, as long as these deposits do not need to be recalled. Our first main result is an interesting equivalence result that the set of allocations achieved with private financial intermediation i.
This equivalence result might seem to vindicate the views of proponents of a CBDC: the socially optimal amount of maturity transformation can likewise be produced in an economy where the central bank has been opened to all. But our equivalence result has a sinister counterpart. If the competition from commercial banks is impaired for example, through some fiscal subsidisation of central bank deposits or by changes in the structure of possible bank runs , the central bank has to be careful in its choices to avoid creating havoc with maturity transformation.
These insights echo similar concerns raised by Cecchetti and Schoenholtz While the central bank is capable of offering the socially optimal deposit contract just as much as commercial banks are, we demonstrate that the rigidity of the central bank's contract with the investment banks leads to different allocations during banking panics.
We have assumed that the loan of the central bank to the investment bank is not callable: this assumption now plays a crucial role. It implies that the central bank's indirect investment in the long asset is protected from early liquidation. We show that this, in turn, either completely deters runs on the central bank or makes runs on the central bank less likely than runs on the commercial banking sector. Depositors internalise this feature and will choose to exclusively deposit with the central bank.
That is, due to the commitment aspect of the rigid contract between the central bank and the investment banks, the central bank becomes the monopoly provider of deposits. A monopoly typically generates a new set of headaches, and this monopoly of a central bank is no exception in that regard. The monopoly power of the central bank can endanger the supply of the first-best amount of maturity transformation in the economy by allowing the central bank to deviate from offering the socially optimal deposit contract, ultimately making depositors worse off as a consequence.
Our results can be compared with other recent studies in the literature that have highlighted different aspects of the potential benefits and risks of a CBDC. For instance, Brunnermeier and Niepelt have provided conditions under which the introduction of a CBDC has no effect on the equilibrium allocation.
Their analysis assumes that the central bank and private-sector financial institutions are equally adept at identifying investment opportunities and monitoring loans, assumptions that we find are unlikely to hold in the real world.
Additionally, their framework does not account for the kind of maturity transformation that characterises the essence of the banking business: the acquisition of long-term illiquid assets financed by short-term liabilities. Other studies, including Andolfatto and Chiu et al. These authors find that an interest-bearing CBDC can lead to a shift of funds out of bank deposits and into the digital currency, which causes a decline in deposits and bank-funded investment.
These conclusions crucially depend on a sufficiently concentrated banking system, and maturity transformation is absent in their analysis. Williamson has argued that, by issuing an interest-bearing CBDC, the central bank can economise on scarce safe collateral, which can be socially beneficial, even though its implementation might undermine central bank independence. Given our results and the comparison with the existing literature, we conclude that a CBDC and the associated central bank open to all is indeed capable of delivering the socially optimal amount of maturity transformation, liquidity insurance, and reduction of bank runs.
However, it also gives an unseen power to central banks. It is not unreasonable to be concerned about the abuse of such power. Authors' note: The views expressed in this column are those of the authors and do not necessarily reflect those of the Federal Reserve System or the Federal Reserve Bank of Philadelphia. Louis Working Paper A. There are many potential advantages to publicly backed digital currencies. They might make payments easier. It is not just in a crisis that CBDC s might compete with banks.
Thus, commercial banks might be drained of the deposits with which they today fund their lending. Disintermediation of the banking system might make impossible the financial magic that allows households to pair long-dated mortgage borrowing with instantaneously redeemable deposits. The budding architects of CBDC s are looking for ways round the problem. The problem of disrupting the banks may be avoidable with clever engineering. But it would be wise to consider whether it even needs avoiding in the first place.
For those willing to entertain futuristic ideas, CBDC s may offer an opportunity to rethink the financial system from the ground up. Several research papers, as summarised by Francesca Carapella and Jean Flemming of the Federal Reserve in a recent review, argue that central banks could preserve maturity transformation by reordering the chain of funding. Today, households deposit money at banks, which park funds at the central bank. If people prefer CBDC s, however, the central bank could in effect pass their funds on to banks by lending to them at its policy interest rate.
Explicit and, perhaps, in constant use. More central-bank lending might sound like an unwarranted expansion of government. And deposits are increasingly concentrated in big banks. The real problem with central-bank financing of banks is the risk of default. To avoid picking winners, policymakers would probably need to fund any institution that can provide satisfactory collateral.
While it's easy to claim bitcoin is being driven by speculators, its rise partly reflects concerns about the ongoing speculation by policymakers on the durability of debt-fuelled growth. Skip to navigation Skip to content Skip to footer Help using this website - Accessibility statement. Markets Equity Markets Bitcoin Print article. Robert Guy Senior Writer. Jan 4, — 4.
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Thongs welcome: New gallery aims to show a party town can do culture. Disintermediation of the banking system might make impossible the financial magic that allows households to pair long-dated mortgage borrowing with instantaneously redeemable deposits.
The budding architects of CBDC s are looking for ways round the problem. The problem of disrupting the banks may be avoidable with clever engineering. But it would be wise to consider whether it even needs avoiding in the first place. For those willing to entertain futuristic ideas, CBDC s may offer an opportunity to rethink the financial system from the ground up. Several research papers, as summarised by Francesca Carapella and Jean Flemming of the Federal Reserve in a recent review, argue that central banks could preserve maturity transformation by reordering the chain of funding.
Today, households deposit money at banks, which park funds at the central bank. If people prefer CBDC s, however, the central bank could in effect pass their funds on to banks by lending to them at its policy interest rate. Explicit and, perhaps, in constant use. More central-bank lending might sound like an unwarranted expansion of government. And deposits are increasingly concentrated in big banks. The real problem with central-bank financing of banks is the risk of default. To avoid picking winners, policymakers would probably need to fund any institution that can provide satisfactory collateral.
Determining which loans and other assets qualify is uncomfortable work. But central banks already make such evaluations in times of crisis. The understanding that they will accept only high-quality assets, plus minimum equity requirements to protect creditors, is supposed to prevent moral hazard.
Another idea is to make banks fund themselves with much more equity, rather than rely on deposits.
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