CBDC and the operational framework of monetary policy

BIS Working Papers No 1126 CBDC and the operational framework of monetary policy by Jorge Abad, Galo Nuño and Carlos Thomas Monetary and Economic Department September 2023 (revised March 2024)JEL classification: E42, E44, E52, G21. Keywords: central bank digital currency, interbank market, search and matching frictions, reserves. 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 2023. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISSN 1020-0959 (print) ISSN 1682-7678 (online) CBDC and the operational frameworkof monetary policy∗Jorge Abad†Galo Nuño†,‡Carlos Thomas†jorgeabad@bde.esgalo.nuno@bde.escarlos.thomas@bde.es†Banco de España‡Bank for International Settlements (BIS), CEMFI and CEPRFirst version: February 2021This version: March 2024AbstractWe analyze the impact of central bank digital currency (CBDC) on the op-erational framework of monetary policy and the macroeconomy. We develop aNew-Keynesian model with a frictional interbank market, central bank deposit andlending facilities, and household preferences for different liquid assets, calibratedto the euro area. CBDC adoption implies a contraction in bank deposits, whichis absorbed by a fall in reserves and, if large enough, increased recourse to cen-tral bank credit. The resulting changes in the operational framework (from ‘floor’to ‘corridor’, and then to ‘ceiling’) thus mitigate the impact of CBDC on credit,investment and output.Keywords: central bank digital currency, interbank market, monetary policy imple-mentation, search and matching frictions, excess reserves.JEL codes: E42, E44, E52, G21.∗Corresponding author: Galo Nuño (galo.nuno@bde.es; Alcalá 48, 28007 Madrid, Spain). A previousversion of this paper was circulated under the title “Implications of central bank digital currency forthe operational framework of monetary policy”. The views expressed in this manuscript are those of theauthors and do not necessarily represent the views of the BIS, the Banco de España, or the Eurosystem.We would like to thank Lea Bitter, Ben Hemingway, Philip Lane, Joël Marbet, Manuel Muñoz, DirkNiepelt, Frank Smets, Javier Suarez, and Anton van Boxtel, as well as conference and seminar participantsat CEMFI Workshop on CBDCs, 2022 CEBRA Annual Meeting, CUNEF, 6th Annual Workshop of theESCB Research Cluster 3, Bank of England BEAR Conference, 3rd Catalan Economic Society Congress,8th SEM Annual Conference, 30th AEFIN Finance Forum, EEA-ESEM Annual Congress, 9th ResearchWorkshop of the MPC Task Force on Banking Analysis for Monetary Policy, ECB Conference on MoneyMarkets, Bank of Canada–Sveriges Riksbank 2nd Conference on the Economics of CBDCs, and CEPR–ECB Conference on The Macroeconomic Implications of CBDCs for their comments. All remaining errorsare ours. Jorge Abad gratefully acknowledges financial support from the Spanish Ministry of Science andInnovation grant PID2020-114108GB-I00.1 1 IntroductionThe potential introduction of a central bank digital currency (CBDC) has gained increas-ing attention in recent years among policymakers and academics. In March 2022, USPresident Biden’s Executive Order on Ensuring Responsible Development of Digital As-sets placed “the highest urgency on research and development efforts into the potentialdesign and deployment options of a United States CBDC”. Similarly, in October 2023the European Central Bank (ECB) announced the start of the preparation phase of its‘digital euro’ project, aimed at laying foundations for a potential euro-area CBDC.While the academic literature has thoroughly analyzed the potential implications ofCBDC for financial stability and monetary policy transmission, much less attention hasbeen devoted to its impact on the monetary policy implementation framework and howthis is likely to shape the macroeconomic effects of CBDC.1Nowadays, most central banksin advanced economies operate a “floor system” in which banks’ demand for liquidity issatiated with an ample supply of central bank reserves (“excess reserves”), and interbankmarket rates are effectively controlled by the interest rate on overnight deposits at thecentral bank.2The introduction of a CBDC has the potential to affect the operationalframework of monetary policy and the conditions in interbank markets if it brings abouta sufficiently large decrease in excess reserves due to the reduction in bank deposits. This,in turn, may have important macroeconomic implications, both in the long run and inthe transi