The case for convenience: how CBDC design choices impact monetary policy pass-through

BIS Working Papers No 1046 The case for convenience: how CBDC design choices impact monetary policy pass-through by Rodney Garratt, Jiaheng Yu and Haoxiang Zhu Monetary and Economic Department November 2022 JEL classification: E42, G21, G28, L11, L15. Keywords: central bank digital currency, interest on reserves, payment convenience, deposit rates, bank lending BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS. This publication is available on the BIS website (www.bis.org). © Bank for International Settlements 2022. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISSN 1020-0959 (print) ISSN 1682-7678 (online) The Case for Convenience: How CBDC Design ChoicesImpact Monetary Policy Pass-Through∗Rodney Garratt†Jiaheng Yu‡Haoxiang Zhu§AbstractBanks of different sizes respond differently to interest on reserves (IOR) policy. Forlow IOR rates, large banks are non-responsive to IOR rate changes, leading to weakpass-through of IOR rate changes to deposit rates. In these circumstances, a centralbank digital currency (CBDC) may be used to provide competitive pressure to drive updeposit rates and improve monetary policy transmission. We explore the implicationsof two design features: interest rate and convenience value. Increasing the CBDCinterest rate past a point where it becomes a binding floor, increases deposit ratesbut leads to greater inequality of market shares in both deposit and lending marketsand can reduce the responsiveness of deposit rates to changes in the IOR rate. Incontrast, increasing convenience, from sufficiently high levels, increases deposit rates,causes market shares to converge and can increase the responsiveness of deposit ratesto changes in the IOR rate.Keywords:central bank digital currency, interest on reserves, payment convenience, depositrates, bank lendingJEL Classification:E42, G21, G28, L11, L15∗The views expressed are those of the authors and do not necessarily reflect those of the BIS. We thankTodd Keister for multiple discussions in the early stages of this work. We also thank Yu An, David Andol-fatto, Ben Bernanke, Darrell Duffie, Zhiguo He, Michael Kumhof, Jiaqi Li, Debbie Lucas, Monika Piazzesi,Alessandro Rebucci, Daniel Sanches, Antoinette Schoar, Harald Uhlig, Yu Zhu, and Feng Zhu, as well asseminar participants at the Bank of Canada, Luohan Academy, MIT Sloan, Nova SBE, Microstructure On-line Seminars Asia Pacific, the University of Hong Kong, the Canadian Economics Association, the JHUCarey Finance Conference, the Philadelphia Workshop on the Economics of Digital Currencies, the CB &DC Online Seminar, Boston University, the Federal Reserve Bank of New York, Shanghai Advanced Instituteof Finance, MIT Computer Science and Artificial Intelligence Lab, the 2021 ECB Money Market Conference,AFA 2022 and the Future(s) of Money Conference, Paris 2022.†Bank for International Settlements. Email: rodney.garratt@bis.org‡MIT Sloan School of Management. Email: yujh@mit.edu.§MIT Sloan School of Management and NBER. Email: zhuh@mit.edu. Haoxiang Zhu’s work on this paperwas completed prior to December 10, 2021, when he joined the U.S. Securities and Exchange Commission.1 “If all a CBDC did was to substitute for cash – if it bore no interest and camewithout any of the extra services we get with bank accounts – people wouldprobably still want to keep most of their money in commercial banks.”—Ben Broadbent, Deputy Governor of the Bank of England, in a 2016 speech1 IntroductionA central bank digital currency (CBDC) “is a digital payment instrument, denominated inthe national unit of account, that is a direct liability of the central bank” (BIS, 2020). Overthe last few years, interest in CBDC has grown to the point where at present 90 percent ofcentral banks are investigating options for introducing CBDCs (BIS, 2021). As indicated inBroadbent’s remarks (in the epigraph), policymakers initially contemplated a CBDC thatduplicated features of cash, without adding design characteristics that would make it morelikely to compete with money issued by commercial banks – the so called disintermediationproblem. However, more recently central banks have taken a broader view, and have beenmore open to the possibility that CBDCs can help them to fulfill their mandates, either inthe present or the future. Central banks are increasingly viewing CBDCs as a way to improvethe payment system, promote financial inclusion, enhance monetary policy transmission, andreduce systemic risk (BIS, 2020).The likelihood that a CBDC w