Abstract: This paper discusses how a Federal Reserve issued retail central bank digital currency (CBDC) could affect U.S. monetary policy implementation. Using a stylized balance sheet analysis, we analyze the effect a retail CBDC could have on the balance sheets of the Federal Reserve, commercial banks, and U.S. households. Then we consider how these balance sheet changes could affect monetary policy implementation for the Federal Reserve. We illustrate that the potential effects on monetary policy implementation from a retail CBDC are highly dependent on the initial conditions of the Federal Reserve’s balance sheet. Moreover, the analysis demonstrates how the Federal Reserve may use its existing tools to manage the effects of a retail CBDC on monetary policy implementation.
As interest in digital currencies picks up around the world, many central banks are evaluating the pros and cons of issuing a central bank digital currency (CBDC). A key consideration in this assessment is the potential effect of a CBDC on monetary policy implementation, including but not limited to the CBDC’s potential interaction with the central bank’s balance sheet, the commercial banking sector, and money markets. These effects will differ depending on the type of CBDC issued and unique characteristics of the issuing country.
In this paper, we focus on how a Federal Reserve issued retail CBDC could affect U.S. monetary policy implementation. Using a stylized balance sheet analysis, we analyze the effect a retail CBDC could have on the balance sheets of the Federal Reserve, commercial banks, and U.S. households. Then we consider how these balance sheet changes could affect monetary policy implementation for the Federal Reserve. This analysis presented is predicated on several assumptions. For example, we define a retail CBDC as a liability of the central bank that is only available to U.S. households and businesses. In addition, the introduction of a retail CBDC occurs at a time when the Federal Reserve is operating with an ample supply of reserve balances and the retail CBDC is unremunerated.
Based on our balance sheet analysis, we find that the effect on monetary policy implementation from a retail CBDC would depend significantly on the scale and variability of CBDC adoption and how this adoption affects the supply of reserves relative to the reserve demand curve. Demand for a retail CBDC will likely depend on several factors, including whether it is widely accessible, how transferrable or substitutable it will be with other retail payment platforms; whether there are limits on the size of holdings, what degree of privacy it provides; and whether it is remunerated. A thorough exploration of these drivers would require weighing pros and cons of alternative technologies used in implementing a retail CBDC. We leave this discussion to future research. In this working paper, we explore implications for monetary policy implementation from a scenario where demand for retail CBDC is high. By high demand, we mean there is widespread adoption of retail CBDC by U.S. individuals and small businesses as a means of payment and as a store of value. Such strong retail CBDC demand could manifest itself as a conversion of physical Federal Reserve notes or deposits at banks, or potentially money funds or U.S. Treasury bills, into retail CBDC. While the exchange of Federal Reserve notes for retail CBDC may not have a direct effect on the supply of aggregate reserves, the exchange of deposits for retail CBDC would lead to a decrease in the supply of aggregate reserves. The decrease in reserves could shift the aggregate reserve supply to the left far enough to intersect with the steep portion of the reserve demand curve. This type of a shift would likely result in upward pressure on the federal funds rate.
We also show through our balance sheet analysis that unwanted, upward pressure on the federal funds rate could be counteracted with existing Federal Reserve policy tools. The Federal Reserve could increase the supply of reserves through permanent open market operations such as reserve management purchases (RMPs).
In addition, the Federal Reserve could also make technical adjustments to administered rates to steer rates within the target range of the federal funds rate. The remainder of this analysis is organized as follows. In Section 2, we review the existing literature on a CBDC as it relates to monetary policy implementation. Section 3 outlines the main assumptions and methodology we use in the balance sheet scenario analysis. Section 4 presents balance sheet scenarios where we demonstrate the potential effects of a retail CBDC on the balance sheets of the Federal Reserve, commercial banks, and U.S. households. In Section 5, we discuss the balance sheet scenarios more generally and what it means for monetary policy implementation. Section 6 concludes.