PrefBlog

BIS has released a working paper by Andrej Sokol, Michael Kumhof, Marco Pinchetti and Phurichai Rungcharoenkitkul titled CBDC policies in open economies:

Focus
Central banks are currently considering issuing digital money to the general public, known as central bank digital currency (CBDC). Much attention so far has focused on the microeconomic benefits of CBDC, while the implications for macroeconomic and financial stability remain less well understood. What are the macroeconomic gains and risks associated with CBDC, particularly if it could be transferred across borders? And how should the central bank set its CBDC policy in the light of these potential benefits and costs?

Contribution
We study the macroeconomic and monetary policy implications of CBDC issuance in a rich quantitative framework. We introduce CBDC into a carefully calibrated and estimated two-country DSGE environment, featuring a realistic financial system, monetary policy (via the conventional policy interest rate and a separate CBDC policy) and fiscal policy. We use the model to examine: (i) the consequences of transitioning to a CBDC economy; (ii) the design of optimal simple rules for CBDC policy, in terms of interest rate or quantity; and (iii) the open economy effects of introducing CBDC.

Findings
Transitioning to a CBDC economy brings about substantial welfare gains, worth over 2% of steady state consumption in the long run. By counteracting financial shocks, CBDC policy would also help stabilise aggregate demand and inflation. For example, the optimised CBDC interest rule that responds systematically to the credit gap improves welfare by over 1% of steady-state consumption. Finally, when countries adopt optimal CBDC policies, they reduce volatilities of cross-border banking exposures and exchange rates by about a third.

Abstract
We study the consequences for business cycles and welfare of introducing an interest-bearing retail CBDC, competing with bank deposits as medium of exchange, into an estimated 2-country DSGE environment. According to our estimates, financial shocks account for around half of the variance of aggregate demand and inflation, and for the bulk of the variance of financial variables. CBDC issuance of 30% of GDP increases output and welfare by around 6% and 2%, respectively. An aggressive Taylor rule for the interest rate on reserves achieves welfare gains of 0.57% of steady state consumption, an optimized CBDC interest rate rule that responds to a credit gap achieves additional welfare gains of 0.44%, and further gains of 0.57% if accompanied by automatic fiscal stabilizers. A CBDC quantity rule, a response to an inflation gap, CBDC as generalized retail access to reserves, and especially a cash-like zero-interest CBDC, yield significantly smaller gains. CBDC policies can substantially reduce the volatilities of domestic and cross- border banking flows and of the exchange rate. Optimal policy requires a steady state quantity of CBDC of around 40% of annual GDP.
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We adopt the calibrated and estimated parameters of the pre-CBDC model in a post-CBDC model that is mostly identical, except for the presence of CBDC. We show that the introduction of CBDC equal to 30% of GDP by a single economy is highly beneficial, yielding long run output gains in that economy of just under 6% and long run welfare gains of around 2%. This is because the introduction of CBDC into a large economy like the US can lower real interest rates due to a reduction in the stock of defaultable debt combined with the funding cost advantage of CBDC over defaultable debt, lower distortionary tax rates due to the budgetary space created by lower real interest rates, and lower monetary frictions due to a reduction in tax-like monetary wedges that represent a move of the economy towards the ideal of the Friedman (1969) rule. Bank balance sheets grow significantly in the long run, while banks’ average cost of funding remains approximately constant, countering the notion that introducing a CBDC inevitably leads to bank disintermediation.
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2. In a contractionary episode the CBDC interest rate should, ceteris paribus, increase rather than decrease. The reason is that increasing the CBDC interest rate relative to the rate on reserves lowers the opportunity cost of holding CBDC. This increases the overall quantity of money and thereby stimulates the economy.

3. A countercyclical CBDC interest rate rule can partly share the burden of a countercyclical Taylor rule for the interest rate on reserves in stabilizing inflation and output, while also stabilizing financial variables. The reason is that the CBDC interest rate works through a money supply channel that complements the intertemporal substitution channel of the interest rate on reserves.

This entry was posted on Monday, April 3rd, 2023 at 7:09 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.