andolfatto

5 Financial stability While the model above does not explicit incorporate the possibility of bank runs, it would be easy to extend the analysis in the manner of Andolfatto, Berentsen and Martin (2019). In what follows, I use the model developed above in combination with this latter paper as an heuristic device to evaluate concerns over the potential for CBDC to destabilize money markets. Cecchetti and Schoenholtz (2017), for example, suggest that CBDC may render bank deposits a less stable form of funding, with unsophisticated depositors prone to moving their money out of private banks into CBDC at the Örst sign of Önancial distress, perhaps leading to a self-fulÖlling bank crisis (Diamond and Dybvig, 1983 and Bryant, 2005). Of course, as they acknowledge, such instruments are already available in the form of cash and treasury debt. The main di§erence with CBDC is its apparent superiority and widespread availability as a ìáight to safetyî vehicle. The run-inducing incentives put in place by CBDC would, by their reckoning, require an heroic expansion of lending by the central bank in a Önancial crisis. Kumhof and Noone (2019) also note that while bank runs have always been possible with currency, the electronic nature of CBDC potentially makes run phenomena much easier and hence, more likely. It is worthwhile pointing out, however, that similar concerns were ex- pressed when the Federal Reserve Bank of the United States implemented its overnight reverse repo (ON RRP) facility in 2014; see Cecchetti and Schoen- holtz (2014). Happily, the Önancial instability risks feared at that time have not materialized and, indeed, activity on the facility has now ceased as higher returns are available elsewhere.15 As a theoretical matter, run risk against the ON RRP facility could be mitigated by sharply lowering the ON RRP interest rate in the event of a heavy ináow of funds. As Kumhof and Noone (2019) point out, the same property can be embedded in the CBDC rate. These authors also stress that stability would require abandoning any Örm commitment to redeem CBDC for reserves at a Öxed exchange rate. This property is reminiscent of the recent regulatory reforms in U.S. money mar- kets that permit the managers of prime money market funds to apply liquidity fees and impose redemption gates at their discretion in the event of heavy 15Cochrane (2015) provides a sober assessment of the Önancial stability risks associated with the Fedís ON RRP facility. 20 redemptions. On top of this, stability could be guaranteed by the central bank itself, standing ready to serve as a lenderñof-last-resort.16 Given that the CBDC experiment has not yet been tried, there is no direct empirical evidence to answer the question of Önancial stability or its likely impact on banking in general. There is, however, some indirect evi- dence worth considering. Grodecka (2019), for example, examines how the Bank of Canada, at its establishment in 1935, slowly replaced existing private banknotes with its own issuances. Her analysis suggests that banks were im- pacted negatively at the time and that some banks reduced the share of loans in their portfolios. It is doubtful, however, that anyone views that interven- tion as crippling Canadian banks today. More importantly, Canadian banks are widely considered to be the paragon of stability. One might also draw on the experience of postal savings system. It is clear from Schuster, Jaremski and Perlman (2016), for example, that U.S. banks did not look favorably on the U.S. Postal Savings System (1911-67). Prior to federal deposit insurance, it appears that the latter facility was used as a áight-to-safety vehicle, lead- ing to measurable outáows of deposits from commercial banks. While small deposits are presently insured, large deposits are not, suggesting that owners of large-value deposits may view CBDC as an attractive run option. On the other hand, it is possible that better designed deposit contractsñembedding the liquidity fees and redemption gates described above, for exampleñcould serve to mitigate this risk. Related to this issue is the question of how a fully-insured CBDC facility might impact the wholesale banking sector. Overnight repo arrangements collateralized with safe securities like U.S. treasuries are attractive relative to bank deposits for large value transactions for at least two reasons. First, government insurance on deposit accounts is typically capped at a relatively small amount ($250,000 in the United States). Second, even where deposits are insured, the money may not be immediately available if a bank is expe- riencing Önancial di¢culties. Since CBDC accounts would be free of these risks, corporate money managers may be inclined to move out of repo markets and into CBDC. To the extent that they do, the e§ect is likely to alleviate the demand for safe assets (Grey, 2019) and render money markets more stable. Conclusion The analysis above suggests the main beneÖt of CBDC will accrue to depos- itors in jurisdictions where banks (and other money services businesses) use their market power to keep deposit rates depressed (or service fees elevated) relative to what would prevail in a more competitive setting. The model pre- dicts that CBDC is likely to increase Önancial inclusion and diminish the use of cash, though the quantitative magnitude of this e§ect is likely to depend on program parameters and the existing degree of Önancial development. It also suggests that CBDC need not have a negative impact on bank lending operations if the central bank follows an interest rate policy rule. Finally, I conclude on the basis of theory and evidence that a well-designed CBDC is not likely to threaten Önancial stability. These conclusions are the implications that follow from a highly abstract and provisional model and so should naturally be viewed with due caution. The model abstracts from several important real world considerations, in- cluding the absence of risk and moral hazard, to name just two factors. On the other hand, it is not immediately clear how incorporating these consid- erations would render the conclusions above directionally incorrect. Only further research can answer this question.