CBDC and the operational framework of monetary policy

Summary

Focus

What effect would a retail central bank digital currency (CBDC) have on monetary policy implementation in the euro area, and how would this shape the macroeconomic effects of a CBDC? The introduction of a CBDC could affect the operational framework of monetary policy and the conditions in interbank markets if it brings about a sufficiently large decrease in excess reserves due to the reduction in bank deposits. This, in turn, could have important macroeconomic implications, both in the long run and during the CBDC adoption phase.

Contribution

This paper analyses the implications of the introduction of CBDC for the operational framework of monetary policy and for the macroeconomy as a whole. To this end, we introduce a CBDC in a tractable New Keynesian model with heterogeneous banks, a frictional interbank market, and central bank standing (deposit and lending) facilities. The model is calibrated to replicate the main monetary and financial aggregates in the euro area. The core of our analysis is on the long-run effects of introducing non-remunerated CBDC. We also assess different policy options that the central bank could implement to preserve the aggregate supply of excess liquidity after the introduction of a CBDC.

Findings

Our analysis predicts that CBDC adoption implies a roughly equivalent reduction in banks' deposit funding. However, this "deposit crunch" has a modest effect on bank lending, and hence on aggregate investment and GDP. This reflects the parallel impact of CBDC on the central bank's operational framework. For moderate CBDC adoption levels, the reduction in deposits is absorbed by an almost one-to-one fall in reserves at the central bank, implying a transition from a floor system –with ample reserves– to a corridor one. For larger CBCD adoption, the loss of bank deposits is compensated by increased recourse to central bank credit, as the corridor system gives way to a ceiling one with scarce reserves.

Abstract

We analyze the impact of introducing a central bank-issued digital currency (CBDC) on the operational framework of monetary policy and the macroeconomy as a whole. To this end, we develop a New Keynesian model with heterogeneous banks, a frictional interbank market, a central bank with deposit and lending facillities, and household preferences for different liquid assets. The model is calibrated to replicate the main monetary and financial aggregates in the euro area. Our analysis predicts that CBDC adoption implies a roughly equivalent reduction in banks' deposit funding. However, this 'deposit crunch' has a rather small effect on bank lending to the real economy, and hence on aggregate investment and GDP. This result reflects the parallel impact of CBDC on the central bank's operational framework. For relatively moderate CBDC adoption levels, the reduction in deposits is absorbed by an almost one-to-one fall in reserves at the central bank, implying a transition from a 'floor' system –with ample reserves– to a 'corridor' one. For larger CBCD adoption, the loss of bank deposits is compensated by increased recourse to central bank credit, as the corridor system gives way to a 'ceiling' one with scarce reserves.

JEL classification: E42, E44, E52, G21

Keywords: central bank digital currency, interbank market, search and matching frictions, reserves