OFR Economic Models Show CBDC Likely to Be "Detrimental" to Financial Stability
Commentary by Steven Lofchie
In a working paper titled "Digital Currency and Bank Sector Stability," the Office of Financial Research ("OFR") found that when banks face financial friction, a central bank digital currency and other types of stablecoins would likely contribute to financial instability and increase the chances for banking sector crises and financial system distress.
In its analysis, OFR researchers created a macroeconomic model of a financial system where digital currency is already fully integrated into the financial system. The authors presumed that because households can hold both digital currency and bank deposits in their portfolio of liquid claims, digital currencies act as a source of competition for bank deposits. To better understand this type of competition’s implications for overall balance sheets of banks, the authors said that they focused on financial instability caused by systemic deleveraging, which leads to fire sales and undercapitalization in the banking sector.
The authors concluded that digital currency is likely to be harmful to financial stability and bank valuations. They said that the increase in the supply of digital currency causes an increase in distress to the financial system, while bank valuations decrease substantially. The authors found, however, that digital currency "can improve" household welfare “significantly.”
Commentary
The macroeconomic modeling used in the analysis is well beyond anything taught in law school, but the conclusion seems fairly common-sensical: at a time when banks are failing, investors could bail out of bank deposits and hold central bank digital currency representing a direct claim on the government. Under the current circumstances, given the general anxiety as to the safety of bank deposits, it seems reasonable that investors would move cash out of banks if there were an easy alternative. Logically, that would be a bad outcome for banks, for asset values generally and likely for the economy.