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CBDC or not to be, that is the question: modeling its impact

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6 Mins.

As central banks investigate the introduction of digital currencies, it is time to ask the question about what impact they might have on economies and financial systems around the world. It’s easier said than done.

Central banks around the world are engaged in a race to explore the possibility of issuing their own central bank digital currencies (CBDCs). By one count, 86% of central banks have a CBDC under research, in development, or being piloted.1 Main motivations range from financial stability to fostering digital financial inclusion to ensuring economic growth. One of the key questions that central banks need to answer before deciding whether to proceed is what the impact on economic and financial stability will be.

Yet modeling this accurately is no simple task. That’s where FNA comes in: FNA is a deep-technology firm specializing in advanced network analytics and simulations. G+D’s recent investment in FNA is part of a strategic funding round and expands on an existing partnership for the development and rollout of a CBDC simulation solution.

Open questions about CBDCs

There are many different issues to be examined. These include technical issues and currency design issues. Questions that need to be addressed include the following:
 

  • What is the technology basis for the currency? Will it use central or distributed ledger technology?
  • Will the digital currency be issued only to intermediaries, such as commercial banks, or also directly to consumers?
  • Can the digital currency be held anonymously? Can it be held by non-residents or overseas financial institutions?
  • How will consumers and businesses adopt and use CBDCs?

The answer to each of these questions will have a significant impact on financial stability and economic growth in the real world. It is therefore unsurprising that hundreds of papers have been written by academics and central bank officials, carefully looking at every technical aspect of introducing a new, official digital currency. These aspects range from security and payment systems through to regulatory issues. There is now a decent body of literature on many specific issues having to do with CBDCs.

FNA has also published its own research paper, titled “Agent-Based Simulation of CBDCs,” that looks at how an agent-based simulation model can answer a range of questions related to CBDCs, including the following:

  • What impact will introducing a CBDC have on the financial and economic system?
  • Can CBDCs be configured without largely impacting the banking-sector balance sheet?
  • Could card companies suffer a substantial decline in their transaction revenues?
Screenshot of the CBDC Simulator with diagrams
A cloud-based, agent-based simulator of CBDC, created with FNA. In agent-based modeling, a system is modeled as a collection of autonomous decision-making entities called agents

There have also been numerous discussions about how CBDCs should be distributed – most central banks are not interested in interacting directly with consumers. Unlike cryptocurrencies, central bank digital currencies have the potential to change the business models of commercial banks, payment providers, and forex players, with wider implications for the financial sector. What exactly are the effects of a CBDC sitting alongside cash as a major part of the economy? Central banks need to know the answer to that before they roll out their digital currencies, as maintaining the stability of the financial system is a key concern.

A less-researched, but nevertheless important, aspect of introducing CBDC is how the public will react. A recent publication by G+D and OMFIF’s Digital Monetary Institute highlighted very sharp differences in public understanding of and attitudes to official digital currencies in different countries.2 Consumers in emerging markets are much more likely to view the potential of CBDCs favorably than those in developed markets and so are more likely to use them for digital payments. Clearly, public trust will also have an important impact on the acceptance of CBDCs and is another factor that must be taken into account.

What impact will introducing a CBDC have?

While a lot of work has focused on answering narrow but challenging questions, such as how a CBDC might affect payment systems, less work has been done on the biggest issue of them all. Namely, what would the impact of a CBDC be on the economy of a country or of a currency zone? 

One of the reasons for this is that this is a very challenging question to address, with multiple dimensions. The process for answering these is not straightforward. One would need to model not only for how an entire economy is currently operating, but also for how a CBDC would interact with that economy under different design criteria. To date, most research has attempted to answer these questions from a macroeconomic perspective and a process of top-level modeling. For example, officials estimate that the uplift to UK GDP would be 3% extra economic growth based on the growth dividend from lower interest rates and reduced taxes.3

While there is real value in the macroeconomic perspective, it would be better to use it in conjunction with tools that can model agent behavior. The 2008 financial crisis dramatically showed us the limits of modeling without accounting for agent behavior. This financial crisis was unexpected in part because planning assumptions didn’t take these behaviors into account.

It is imperative that agent behaviors are taken into account in crucial decisions about the design criteria for digital currencies. This means that policy-makers, and those affected by them, need to have access to a tool such as FNA’s CBDC Simulation, where they can see the impact at an agent level of different digital currency design decisions. It is the difference between having access only to a top-level view, or being able to zoom in on the impact on commercial banks and payment system participants.

The prize is worth the price

The introduction of a CBDC is a once-in-a-generation opportunity to reshape the payment landscape. It is vital that the impact of different design options is properly understood and modeled. Central banks and the wider financial system need to know and plan for the impact of CBDCs on everything from financial services and digital payments to other issues such as the effects on wider economic growth.

It is of the utmost importance that the impact of CBDC is analyzed, and we must take all factors into account. While this is a very challenging task, it becomes easier with the right tools – with CBDC Simulation from FNA, for example.

  1. “Ready, steady, go? – Results of the third BIS survey on central bank digital currency,” Bank for International Settlements, January 2021

  2. “Consumer attitudes to CBDC: Considerations for policy-makers,” December 2021

  3. “The macroeconomics of central bank digital currencies,” Barrdear and Kumhof, Journal of Economic Dynamics and Control, May 2021

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