Financial innovation and monetary policy: Challenges and prospects

Financial innovations are expected to gradually reshape the financial sector. This paper describes recent technological developments and their possible impact on monetary policy and financial stability. A focus is put on the prospects for digital currencies, which potentially have the most profound implications for monetary policy. We find that privately issued digital currencies could transform the present financial system substantially, if they gain considerable market shares, while there may be a benefit from currency competition in disciplining monetary policy. The introduction of a central bank digital currency would also challenge the present fractional reserve system at its core and could finally lead to a more stable financial system.