CBDC and monetary policy implementation
In this paper, James Clouse analyzes the implications of new financial instruments such as central bank digital currencies (CBDCs), stablecoins, and narrow banks on monetary policy implementation. His framework is one of interconnected demand and supply curves for all financial instruments in a competitive model of financial markets with two types of frictions: (i) portfolio allocation costs that
determine the extent to which households and financial intermediaries are willing to “reach for yield” in their asset allocation decisions and (ii) balance sheet costs for financial intermediaries that determine the extent to which they are willing to expand their balance sheet to take advantage of potential profit opportunities. Clouse highlights the following issues:
- The interest rate offered on wholesale CBDC (available to banks and non-banks) becomes another very important policy rate that would likely need to be moved in tandem with the interest rates on reserves and the interest rate on other Federal Reserve liabilities in achieving any desired level of short-term interest rates.
- Another issue would be the appropriate setting of the wholesale CBDC rate relative to the Federal Reserve’s other administered rates. In the model, the wholesale CBDC rate is set exactly in the middle of the range between the interest rate on reserves and the interest rate on other Federal Reserve liabilities.
- The household preference for retail CBDC (available to households) comes at the expense of deposits, funding costs for intermediaries move higher and the equilibrium loan rate moves higher as well with a corresponding decline in borrowing by businesses.
A Field Guide to Monetary Policy Implementation Issues in a New World with CBDC, Stablecoin, and Narrow Banks
Author: James A. Clouse
From: Federal Reserve Board
CBDC and the Central Bank trilemma
In this paper, Fernández-Villaverde et al. explore the potential conflict that may arise when a central bank offers an account-based central bank digital currency (CBDC). The authors demonstrate the existence of a central bank trilemma, where a central bank involved in financial intermediation can only achieve at most two of three objectives: a socially efficient allocation, financial stability, and price stability. Their model is based on Diamond and Dybvig (1983) with a central bank that issues CBDCs and has two types of CBDC investors, namely, patient and impatient ones. Since the central bank is the sole investor in the real production technology to satisfy the consumption needs of agents it needs to liquidate a share of its projects. To attain optimal risk-sharing, the central bank needs to maximize real long-term investment while also offering optimal consumption levels to investors who have to consume early i.e. the impatient ones. The central bank though needs to deter patient investors from consuming early by threatening inflation:
[W]e show that the central bank can offer optimal risk-sharing while deterring central bank runs only by credibly threatening with inflation, that is, by giving up her third objective. We believe that our results are highly policy-relevant when contemplating the introduction of a CBDC. According to our analysis, the simultaneous, sure implementation of full price stability and optimal risk-sharing contracts is impossible. Moreover, central bank runs or the required inflation threat to deter such runs may undermine trust in the institution of the central bank. We further show that a similar result holds in a decentralized economy where banks and firms finance respectively run the real economy, and where nominal deposit accounts take the role of a CBDC.
Central Bank Digital Currency: when price and bank stability collide
Authors: Jesús Fernández-Villaverde, Linda Schilling, Harald Uhlig
From: University of Pennsylvania, Washington University in St. Louis, University of Chicago
