The working paper traces the effects of operations with CBDC through several scenarios and concludes the Fed will have it under control.
On Tuesday, the United States Federal Reserve released a study on the possible effects of a retail central bank digital currency (CBDC) on U.S. monetary policy implementation. The study, dated April, was a staff working paper titled “Retail CBDC and U.S. Monetary Policy Implementation: A Stylized Balance Sheet Analysis.”
The paper considered four scenarios that illustrate the potential effects of a retail CBDC on monetary policy from the perspective of three stakeholder groups: the Fed, commercial banks and U.S. households.
The first scenario involved exchanging cash for CBDC, which affected the categorization of assets at the Fed and in the household involved, but had no effects on policy implementation. The following three scenarios showed a cascading effect that began with individuals withdrawing CBDC from a commercial bank when the money had been deposited as cash.
Assuming fixed bank demand for reserves, the scenarios went on to discuss commercial banks’ reaction to the reduction in cash reserves resulting from CBDC withdrawals. If those withdrawals lead to a shortfall in reserves, banks have the choice of offloading certain securities or loans to build up their cash holdings again, or to increase deposits by offering more attractive terms on their products. That, in turn, could lead to higher short-term interest rates and reduce demand for CBDC by holding deposits in banks longer.
If interest rates rise too abruptly, the Fed could turn to the discount window and standing repo facility to moderate the rates, and if that fails, the next step would be reserve management purchases. Those technical operations are discussed in some detail.
The potential incoming Fed vice chair might be taking a hard look at stablecoins and CBDCs. https://t.co/EhmAYnQo7t
— Cointelegraph (@Cointelegraph) May 19, 2022
According to the authors, the paper showed 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.” Their analysis also demonstrated how the Fed could use existing tools to manage the impact of retail CBDC on monetary policy implementation.
Related: Brainard tells House committee about potential role of CBDC, future of stablecoins
The paper is the latest sign of the flurry of activity around CBDCs in the U.S. and other countries.