Monetary policy with CBDC

How does a CBDC affect domestic monetary policy?

Dirk Niepelt analyzes a two-tiered monetary system, a purely CBDC-based monetary arrangement, as well as an integrated system with deposits, reserves, and CBDC in order to address two questions:

What are the characteristics of optimal monetary policy in a two-tiered system? Does the introduction of CBDC alter equilibrium outcomes?

His model consists of an infinite horizon production economy with a continuum of homogeneous infinitely-lived households. The households own a succession of two-period lived, monopsonistic banks and of one-period-lived, competitive firms. Monetary and fiscal policy is determined by a consolidated government/central bank. There are two means of payments issued by banks and the central bank respectively: these are deposits on the one hand and CBDC or “reserves for all” on the other. Finally, the model allows for resource costs of circulating these means of payment and running the payment system.

We have also generalized the Brunnermeier and Niepelt (2019) result on the macro irrelevance of CBDC and we have shown that a bank based payment system requires higher taxes. This could strengthen the political support for the introduction of CBDC and it could imply that central bank independence is under greater threat in a deposit rather than CBDC based payment system. We have used the equivalence result to assess the funding cost reduction for U.S. banks due to the fact that they can issue deposits. The model implied annual funding cost reduction amounts to up to 0.8 percent of GDP during the period 1999–2017.

Monetary Policy with Reserves and CBDC: Optimality, Equivalence, and Politics
Author: Dirk Niepelt
From: University of Bern

How does a CBDC affect the international monetary system?

Ferrari and al. argue that a CBDC does not only have domestic macroeconomic implications, it affects the rest of the world as well. They use a two-country DSGE model with financial frictions and add a CBDC instrument to the menu of monetary assets available.  They look at 3 CBDC designs: CBDC with a fixed interest rate; one where CBDC is supplied according to a quantity-based rule; and CBDC with a flexible (Taylor-rule-type) interest rate.

The main finding  is that domestic issuance of a CBDC increases asymmetries in the international monetary system by reducing monetary policy autonomy in the foreign economy. In particular:

• In the absence of a CBDC, optimal monetary policy is similar in the home and foreign economies, with differences being driven by slight differences in the calibration of the shock processes. Both central banks respond to inflation more aggressively than to output, and implement some degree of interest rate smoothing ;
• In the presence of a CBDC, there are larger exchange rate movements due to overshooting after a shock and the risk-free rate in the foreign economy moves more strongly. As a result, for the domestic economy,  depending on the CBDC design, optimal monetary policy warrants a marginally stronger reaction to inflation and a weaker response to output. The foreign economy, however, is affected much more. Independently from CBDC design, optimal monetary policy warrants a central bank response to inflation and output that is between 50% to 100% stronger.  The introduction of a CBDC by the domestic central bank forces the foreign central bank to alter its monetary policy stance to try and mitigate the stronger international spillovers created by the presence of the CBDC.

Central bank digital currency in an open economy
Authors: Massimo Minesso Ferrari, Arnaud Mehl, Livio Stracca
From: ECB