A recent report from the Canadian financial authority investigates central bank-issued digital currencies and how they might improve the economy.
Researcher S. Mohammad R. Davoodalhosseini of the Bank of Canada, the country's central bank, published a working paper[1] regarding the potential benefits of central bank-issued digital currencies (CBDCs). He reviews the state of CBDCs and offers a model to study the coexistence of a CBDC and a fiat currency.
Davoodalhosseini begins his paper by contextualizing CBDCs. He notes, "There has been a great deal of discussion in recent years about the effects of introducing [CBDCs] into economies and whether cash should be eliminated." He provides the examples of Sweden[2] and China[3], which are considering their own CBDCs.
As part of this discussion, he asks the following questions:
"Should central banks eliminate cash from circulation? What would be the optimal (i.e., welfare-maximizing) monetary policy if agents [consumers] can choose between cash and CBDC? And quantitatively, what are the welfare gains of introducing CBDC into the economy?"
To answer these questions, Davoodalhosseini builds a model whereby both cash and a CBDC are available to consumers, and compares it to cash-only and CBDC-only systems.
According to Davoodalhosseini, each scheme would yield different results. The CBDC-only plan, for example, would allow more allocations and the ability to earn nonlinear interest, but there would be a loss in economic welfare resulting from the costs associated with carrying a CBDC (such as consumers' lack of anonymity).
When both cash and a CBDC are available, the interplay is a bit complicated. Davoodalhosseini notes that a CBDC would impose "a constraint" in reaching optimal monetary policy. If such a constraint were too rigid, "then the central bank would prefer to have only one means of payment used
