Central Bank Cryptocurrencies in a Competitive Equilibrium Environment: Can Strong Money Demand Survive in the Digital Age?

Abstract

This chapter discusses the possible macroeconomic consequences of the introduction of cryptocurrencies by central banks (so-called central bank cryptocurrencies or CBCCs) in a competitive equilibrium environment. In this setup, central banks set not only the money supply, but also the interest rate on CBCCs, whereas bond interest rates, the price level, and the exchange rates between CBCCs are determined in competitive markets. We first resolve a severe confrontation between the quantity theory of money (QTM) and the fiscal theory of the price level (FTPL) in that, as long as the currency interest rate lies below the bond interest rate, the QTM is applicable in principle. However, once the bond interest rate (asymptotically) matches that of the currency, the QTM is replaced by the FTPL, or the monetary and fiscal theory of the price level (MFTPL), in which the government’s budget constraint as well as money market conditions jointly work to determine the price level as discussed in Chapters “Public Bonds as Money Substitutes at Near-Zero Interest Rates: Disequilibrium Analysis of the Current and Future Japanese Economy and Long-Run Mild Deflation Under Fiscal Unsustaina-Bility in Contemporary Japan”. We then investigate whether the introduction of CBCCs plays a role in the disappearance of strong money demand (currently present at near-zero interest rates in Japan) and its alternatives. We find that if a central bank sets the currency interest rate below a near-zero bond interest rate, then strong money demand disappears, and the massive issuance of long-term public bonds is no longer absorbed in currency markets. However, once the consolidated government succeeds in lowering the currency interest rate to be deeply negative, it can obtain immense seigniorage, allowing it to repay these public bonds. In addition, if the bond interest rate also falls, even below zero for long periods, then the government can exploit seigniorage from CBCC holders without limit.