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

Table of Content

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

9. Conclusion

Objectives & Core Themes

This thesis aims to identify the implications of a central bank-issued digital currency (CBDC) on monetary policy, financial stability, and the balance sheets of central banks, commercial banks, and the non-bank private sector. By conducting an exploratory scenario analysis within the context of the Eurozone, the research seeks to evaluate how different implementation modes of a CBDC challenge the existing monetary system and traditional economic theories.

• The potential shift in monetary system dynamics and control through CBDC.
• Scenario-based analysis comparing complementarity versus replacement of existing money types.
• The theoretical clash between the New Currency School and the Banking School.
• Impacts on financial stability and the "Too Big To Fail" paradigm.
• Restructuring of commercial and central bank balance sheets.

Excerpt from the Book

Summary of Chapters

1. Introduction: Outlines the rise of digital currencies, central bank interest in CBDCs, and the motivation for using a scenario-based research approach.

2. The era of digital currencies: Defines core concepts like cryptocurrencies and electronic money, while assessing the current state of global central bank research on CBDCs.

3. Methodology: Justifies the use of qualitative scenario analysis and describes the derivation of four implementation modes for a CBDC.

4. Status quo: Monetary policy and the banking system in the Euro Area: Reviews the ECB's current policy instruments, the fractional reserve banking system, and the state of bank balance sheets.

5. Theoretical concepts and literature review: Contrasts the "New Currency School" and the "Banking School" and introduces the theoretical framework of the sovereign money model.

6. Implications of a CBDC on monetary policy, financial stability & balance sheets: Analyzes the macroeconomic consequences and balance sheet shifts across the four defined scenarios.

7. Discussion of scenarios in two schools: Currency vs. Banking School: Categorizes the proposed CBDC scenarios into the clashing perspectives of established monetary economic schools.

8. Discussion and suggestion for further research: Critically evaluates the findings and discusses the limitations of current theoretical models regarding CBDC implementation.

9. Conclusion: Summarizes the thesis, highlighting that CBDCs could increase monetary competition and improve central bank control, depending on the implementation design.

Keywords

Central Bank Digital Currency, CBDC, Monetary Policy, Financial Stability, Balance Sheets, Eurozone, Fractional Reserve Banking, Sovereign Money, New Currency School, Banking School, Money Supply, Digital Economy, Cryptocurrencies, Seigniorage, Quantitative Easing

Frequently Asked Questions

What is the core focus of this thesis?

The thesis explores the potential implications of a central bank-issued digital currency (CBDC) on the existing financial ecosystem, specifically focusing on monetary policy, financial stability, and banking balance sheets in the Eurozone.

Which thematic areas are central to this research?

The work covers the transition from cash to digital means, the role of central banks in controlling money supply, the mechanics of fractional reserve banking, and the comparative analysis of different theoretical economic schools of thought.

What is the primary objective of this work?

The primary objective is to conduct a scenario analysis to determine how a CBDC could either complement or replace current money forms and what resulting effects this would have on central bank, commercial bank, and private sector balance sheets.

Which scientific method is utilized in the paper?

The author employs an exploratory and qualitative scenario analysis, supported by literature review and a semi-structured expert interview with a representative of the Swedish Riksbank.

What does the main analytical part cover?

The main part analyzes four distinct CBDC implementation scenarios—ranging from supplementary CBDC to a full sovereign money model—and their specific impacts on price stability, interest rate transmission, and banking solvency.

Which keywords define this research?

Key terms include CBDC, monetary policy, financial stability, balance sheets, fractional reserve banking, sovereign money, and the clashing theories of the Currency versus the Banking School.

How does a CBDC change the "Too Big To Fail" dynamic?

By providing an alternative, risk-free account directly at the central bank, a CBDC reduces the monopoly of commercial banks over the payment system, potentially diminishing the systemic reliance on bank bailouts and moral hazard incentives.

What is the significance of the "New Currency School" in this paper?

The New Currency School provides the theoretical foundation for arguments favoring state control over money creation and the separation of money from credit, which forms the basis for the proposed sovereign money model scenarios.