How a Central Bank Digital Currency Would Affect the Money Supply

A central bank digital currency (CBDC) is an electronic liability of a central bank directly accessible to the public, rather than a commercial bank deposit. Were retail CBDC widely adopted, it could restructure how broad money supply is created and held. The core risk is that savers might shift deposits from commercial banks to risk-free central bank accounts, draining loanable funds from the private banking system and reducing the amount of credit expansion (and thus broad money growth) that the economy can sustain. Conversely, a carefully designed CBDC might leave money-creation dynamics unchanged by capping individual holdings, paying negative rates, or keeping issuance small. The effect depends entirely on implementation choices that central banks have not yet firmly made.

Why the money-supply question matters

To understand CBDC’s potential impact, you need first to see how money is created today. The federal funds rate is set by the Federal Reserve, but most money in the economy is not created by the Fed—it’s created by commercial banks. When a bank makes a loan, it credits the borrower’s account with a deposit. That deposit is money. The borrower now has a claim on the bank; other people can pay the borrower by transferring the deposit. Deposits circulate as a medium of exchange. In this way, lending creates money.

The amount of money created this way depends on how much the banking system is willing to lend and how much customers are willing to borrow. The Fed influences both through policy (interest rates, reserve requirements), but it doesn’t directly control the money supply—banks do, in response to demand and regulatory constraints.

If a CBDC were introduced and designed to be widely used, it would create a new way to hold money that is not a bank deposit. Instead of your paycheck crediting a commercial bank account, it could credit a central bank account (your CBDC wallet). If savers preferred CBDC because it’s risk-free and interest-bearing, they might withdraw deposits from commercial banks and shift to CBDC. This creates a problem: banks need deposits to fund loans. Fewer deposits means fewer loans, which means less money creation, which means tighter monetary conditions—unless the central bank actively intervenes.

The deposit-flight scenario

The classic worry is deposit flight: as soon as CBDC becomes convenient and widely accessible, nervous savers move money out of commercial banks during stress periods. In normal times, savers accept modest interest on bank deposits because they’re insured by the Federal Deposit Insurance Corporation (up to $250,000) and familiar. But during a banking crisis, or if CBDC pays a better rate, they might shift.

If a significant portion of deposits flee the banking system, the remaining banks face a classic balance-sheet squeeze. Deposits fund lending. No deposits, no loans. Banks would have to cut credit. Borrowers would struggle to refinance mortgages, small businesses would face capital shortages, and investment would contract. The money supply (particularly M2, the broad measure including deposits and cash) would shrink unless the central bank compensated by directly expanding its own lending or asset holdings.

In a severe case, deposit flight could trigger a banking crisis. The central bank would then have to “lender of last resort”—flooding banks with central bank credit to replace lost deposits. This has happened many times historically and is partly why deposit insurance exists. CBDC adds a new vulnerability: it offers an easy off-ramp for deposits that bypasses insurance altogether. Why keep your money in an insured bank account paying 4% if you can hold risk-free central bank digital money paying 5%?

How central banks are designing against this

Policymakers recognize this risk, which is why every major central bank exploring retail CBDC has proposed safeguards. The most common approach is holding limits: you can’t store more than a certain amount in CBDC—perhaps $10,000 or $100,000 per person. This keeps CBDC small relative to the total money supply and prevents wholesale deposit flight.

Another tool is negative interest rates on CBDC during stress periods. If CBDC becomes a vehicle for panic, the central bank can charge holders a fee, making it expensive to hold large balances. This discourages hoarding and redirects money back to the banking system.

A third approach is tiered remuneration: CBDC pays the policy rate on modest balances (say, $100,000) but zero or negative on anything above that. This way, ordinary savers get a safe asset and a reasonable return, but there’s no financial incentive to move an entire net worth into CBDC.

Some jurisdictions—particularly in the eurozone and Singapore—have proposed wholesale CBDC only, available to financial institutions but not the public. This eliminates deposit competition entirely. Money supply is created the same way as today; only settlement and clearing change.

The credit-creation angle

The deeper issue is how CBDC affects credit expansion. Today, broad money growth depends on bank lending. When a bank extends a $200,000 mortgage, it creates $200,000 in deposits. That mortgage is an asset on the bank’s balance sheet; the deposit is a liability. Both grow together. The borrower now has money to spend, which ripples through the economy.

In a CBDC regime, if savers hold central bank digital money instead of bank deposits, the central bank can’t expand broad money by simply leaving interest rates unchanged. It would need to actively purchase assets (bonds, securities) to inject liquidity, or it would need to allow banks to borrow directly from the central bank at favorable rates to replace lost deposits. Either way, the central bank’s balance sheet must grow to offset the shrinkage in bank-created money.

This is not necessarily bad—central banks can expand the money supply through asset purchases, as they did during quantitative easing. But it shifts the mechanics. Instead of broad money growing because banks decide to lend more, it grows because the central bank is actively injecting central bank liabilities. The process becomes more transparent and more directly controlled by the central bank, and less responsive to private credit demand.

International variations

The European Central Bank has been cautious, proposing a digital euro with holding limits and a prohibition on paying interest. This design minimizes incentive for deposit displacement while keeping the euro competitive with private payment systems (like mobile wallets).

Sweden’s Riksbank and the Bank of Canada have studied CBDC to support cashless payment systems, less concerned with deposit dynamics (deposits are already declining as cash fades). Singapore’s central bank has tested wholesale CBDC to improve settlement speed without a retail component.

The Federal Reserve’s stated position is that a U.S. CBDC would include safeguards—but has not committed to a rollout timeline. The hesitation reflects political and technical unknowns: design specifics matter enormously, and different choices lead to radically different outcomes.

The money-supply baseline

If a CBDC is rolled out with holding limits and no interest, or with negative rates, it might have negligible impact on money supply. CBDC would simply be another form of currency (like e-money or digital dollars in a mobile wallet), and the creation of broad money would continue as today: through bank lending, supported by a stable deposit base.

If a CBDC is rolled out with no limits, competitive interest rates, and a user-friendly interface, and it becomes preferred to bank deposits, then broad money growth would slow unless central banks actively compensated. Interest rates might need to be lower, or the central bank’s balance sheet might need to be larger, to maintain the same level of credit expansion.

Empirically, we won’t know the effect until CBDC is deployed and used at scale. The design choices made in the next 2–3 years will largely determine whether CBDC reshapes money supply dynamics or leaves them intact.

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