Research Topics

Fractional reserve regimes generate fragile banking, and full reserve regimes (e.g., narrow banking) remove fragility at the cost of suppressing the role of banks as lenders. A Central Bank Digital Currency (CBDC) could provide safe money, but at the cost of potentially disrupting bank lending. Our aim is to avoid this potential disruption. Building on the recent literature on CBDCs, in this study we propose what we call the “CBDC next-level model,” whereby the central bank creates money by lending to banks, and banks on-lend the proceeds to the economy. The proposed model would allow for deposits to be taken off the balance sheet of banks and into the balance sheet of the central bank, thereby removing significant risk from the banking system without adversely impacting banks’ basic business. Once CBDC is injected in the system, irrespective of however it is used, wherever it accumulates, and whoever holds and uses it, it will always represent central bank equity, and no losses or defaults by individual banks or borrowers can ever dent it or weaken the central bank’s capital position or hurt depositors. Yet, individual borrowers and banks would still be required to honor their debt in full, lest they would be bound to exit the market or even be forced into bankruptcy. The CBDC next-level model solution would eliminate the threat of bank runs and system collapse and induce a degree of financial stability (“super-stability”) that would be unparalleled by any existing banking system.

In a seminal 1972 paper, Robert M. May asked: “Will a Large Complex System Be Stable?” and argued that stability (of a broad class of random linear systems) decreases with increasing complexity, sparking a revolution in our understanding of ecosystem dynamics. Twenty-five years later, May, Levin, and Sugihara translated our understanding of the dynamics of ecological networks to the financial world in a second seminal paper, “Complex Systems: Ecology for Bankers.” Just a year later, the US subprime crisis led to a near worldwide “great recession,” spread by the world financial network. In the present paper we describe highlights in the development of our present understanding of stability and complexity in network systems, in order to better understand the role of networks in both stabilizing and destabilizing economic systems. A brief version of this working paper, focused on the underlying theory, appeared as an invited feature article in the February 2020 Society for Chaos Theory in Psychology and the Life Sciences newsletter (Hastings et al. 2020).