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According to a central bank researcher, the United States and Canada could benefit from economic welfare gains if a central bank-issued cryptocurrency was introduced.

The Bank of Canada’s Mohammad R. Davoodalhosseini stated that a Central Bank Digital Currency (CBDC) had the potential to “lead an increase of up to 0.64 percent in consumption for Canada and up to 1.6 percent for the US, compared with their respective economies if only cash is used.”

However, the key question Davoodalhosseini posed is whether cash and a digital form of fiat currency could co-exist under an ‘optimal’ monetary policy.

The case for substituting cash with a CBDC

In a working paper, Davoodalhosseini based his findings on detailed modelling and mathematical calculations. He argues that a country’s economic welfare – in this case Canada and the United States – could be improved by swapping cash with a CBDC.

This is something several central banks are currently considering, providing implementation isn’t too costly.

As Davoodalhosseini explains:

“Having both cash and CBDC available to agents (consumers) sometimes results in lower welfare than in cases where only cash or only CBDC is available. This fact suggests that removing cash from circulation may be a welfare-enhancing policy if the motivation to introduce CBDC is to improve monetary policy effectiveness.”

 What’s more, the introduction of a CBDC could give central banks even more flexibility when adjusting current monetary policy.

“This is because the central bank can monitor agents’ portfolios of CBDC and can cross-subsidise between different types of agents, but these actions are not possible if agents use cash,” he says.

How a CBDC system would work

 In order for a CBDC to be successful, Davoodalhosseini suggests the adoption of a debit card system owned and monitored by the central bank. By outsourcing operations to other institutions such as ‘FinTech’ companies, central banks could keep their costs down too.

“Each individual can have an account with the central bank, and individuals can use these balances for purchases of goods and services. Such a system provides access to the central bank balance sheet in electronic format for all agents in the population and allows them to earn interest on their balances,” Davoodalhosseini said.

“Currently, only some financial institutions have this privilege. With such a system, monetary policy directly affects agents’ decisions to carry balances, rather than through the financial system, making the implementation of monetary policy more transparent.”

The effect of a CBDC on the banking system

Even though Davoodalhosseini is quick to point out that the effects of a CBDC on the banking system are yet to be explored, he believes it would be ‘non-trivial’.

For example, it would provide direct access to a deposit account that is much safer than those at commercial banks. This elevated level of competition may lead banks to improve their services by offering cheaper and better products.

“On the other hand, an increased level of competition may lead banks to invest in (or give loan to) riskier projects, resulting in a less stable financial system,” he argues.

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