Banks in our model are financially constrained, and the liquidity premium on bank deposits affects the level of aggregate investment. We study the optimal design of a digital currency in this setting, including whether it should pay interest and how widely it should circulate. We highlight an important policy tradeoff: while a digital currency tends to promote efficiency in exchange, it can also crowd out bank deposits, raise banks' funding costs, and decrease investment. Despite these effects, introducing a central bank digital currency often raises welfare.
Should Central Banks Issue Digital Currency?
WP 19-26 - We study how the introduction of a central bank-issued digital currency affects interest rates, the level of economic activity, and welfare in an environment where both central bank money and private bank deposits are used in exchange.