Issuing central bank digital currencies (CBDCs) is likely to become a necessity to preserve access to public money in an increasingly digital economy. Eighty-seven central banks worldwide are currently exploring CBDCs. This includes the ECB, which considers the merits of a retail CBDC – the possibility for everyone to use public money for digital payments.1
Research can help policy by allowing to draw on sound analysis, informing policy trade-offs and design choices as central banks prepare to potentially issue retail CBDCs.2 Two sets of questions are particularly relevant: What are their implications for both financial stability and monetary policy? And what are the areas where the frontiers of our knowledge on this topic can be further expanded?
In taking stock of the advances in research on CBDCs, it appears that CBDCs have potentially far-reaching implications for the monetary and financial system as a whole. And careful design will be crucial in allowing us to maximise the benefits of CBDCs while managing any unintended consequences.
Financial stability implications
Risks to financial intermediation
A widely held view is that CBDCs could crowd out bank deposits and payment activities, which may impair financial stability and reduce lending to the economy. But a growing body of research suggests that this view is not so clear-cut and that the impact on bank intermediation and lending could be manageable.3
First, risks depend crucially on the choices that central banks make. Central banks can entrust financial intermediaries with distributing CBDCs, preserving their role – and their added value – in providing front-end services. Central banks can also adapt CBDC design features, which are found to be strong drivers of the potential demand for CBDCs.4 Safeguards, including tiered remuneration or holding limits, can be effective ways of mitigating risks.5 And central banks can provide abundant and favourable funding to limit strains from possible changes in the composition of bank funding, which research suggests is neutral in terms of capital allocation (Brunnermeier and Niepelt 2019, Committee on Payments and Market Infrastructures 2018).
Second, the issuance of CBDCs can also have positive implications for the financial system. As the demand for cash weakens, issuing CBDCs could ensure that sovereign money continues to play its role in underpinning confidence in payments by providing the reference value for all forms of private money.6 A CBDC could also improve capital allocation by facilitating access to payments and reducing transaction costs (Keister and Sanches 2019, Assenmacher et al. 2021). It could foster competition in banks’ funding markets by reducing banks’ market power (Andolfatto 2020, Chiu et al. 2019). And CBDCs could provide innovative payment opportunities, levelling the playing field for banks that are exposed to competition from new players, like Big Tech firms.
Recent research findings suggest that these effects extend even further. One such finding is that a CBDC can foster bank intermediation. An increase in its remuneration would force banks to raise the interest on their deposits, leading to higher CBDC and deposit balances and – in turn – more lending (Monnet et al. 2021). This ‘crowd-in effect’ is found to occur even in the absence of remuneration. As the use of cash declines, a CBDC provides an alternative to deposits and a floor on rates, limiting banks’ monopoly profits and encouraging them to increase lending (Chiu and Rivadeneyra (2021). Such effects are found to potentially increase lending by almost 2% and output by about 0.2% in the US.7
Potential effects in times of crisis
However, the effects of issuing CBDCs are potentially more elevated when there is a sudden loss of confidence in banks. Research has therefore looked at whether CBDCs can exacerbate systemic crises.
Beyond providing a safe asset,8 the novelty with CBDCs is that they would provide access to a safe asset that – unlike cash – could potentially be held in large volumes and at no cost, accelerating ‘digital runs’, which could even be self-fulfilling (Kumhof and Noone 2018). Admittedly, a number of lines of defence – such as deposit insurance, supervision and the lender of last resort – would have to fail for such risks to materialise. But new research further shows that the increased risk of bank runs due to CBDCs can be contained, by adequately designing and calibrating safeguards.9 A notable finding is that a CBDC could itself be used as a tool to counter such risks. It could provide real-time information on deposit flows and allow the central bank to respond more swiftly, which in turn would help to stabilise expectations by increasing depositor confidence (Keister and Monnet 2020).
Monetary policy implications
Factors that could weaken monetary policy transmission
The implications of CBDCs for monetary policy have been studied in less depth so far, but they are no less important. In particular, if a CBDC were issued without safeguards to constrain its use, the transmission of monetary policy could be weakened.
An unconstrained CBDC could potentially affect banks’ funding structures and in turn financing conditions. The size of these effects, which is linked to the overall take-up of CBDC, is shown to depend on design features such as payment convenience and remuneration.10
An unremunerated and unconstrained CBDC could also entrench the zero lower bound for interest rates, as no other asset could yield a negative interest rate in the presence of a liquid central bank liability with neither remuneration nor holding constraints.
These findings highlight the type of trade-offs faced by central banks. A digital euro, for instance, should not be ‘too successful’ as a form of investment, but ‘successful enough’ as a convenient payment instrument. In other words, the ‘CBDC trilemma’ – according to which objectives of payment efficiency, financial stability and price stability cannot all be achieved together – needs to be solved (Schilling et al. 2020).
A ceiling on individual CBDC holdings could go a long way in preventing large deposit outflows. But this would also risk reducing its usefulness as a means of payment, by reducing its scale and scope. To address this issue, solutions linking CBDC accounts to private money accounts could be implemented, allowing large payments to be made.11
Another option would be a tiered remuneration that would disincentivise excessive CBDC holdings by making them less attractive above a certain threshold.12 ECB research shows that the central bank could steer the quantity of CBDC in circulation by setting its lending and deposit rates as well as collateral and quantity requirements (Assenmacher 2021).
Factors that could strengthen and speed up monetary policy transmission
Conversely, a remunerated CBDC could accelerate and strengthen monetary policy transmission.13 Indeed, CBDC holdings and bank deposits would depend on both CBDC remuneration and policy rates, requiring coordination between the two rates (Jiang and Zhu 2021).
Changes in CBDC remuneration would immediately affect the wealth of households and firms and force banks to adjust their deposit rates more quickly, strengthening bank-based transmission.
Issuing a CBDC could also lead to a shift in bank funding towards wholesale funding, the cost of which tends to be more sensitive to the central bank’s policy rate, which would similarly strengthen the transmission of monetary policy.
Open research questions
The speed at which CBDC research has advanced is truly remarkable, considering that it was virtually unexplored just a few years ago. This research provides a valuable framework and solid evidence to guide central banks’ thinking as they prepare for the possible issuance of CBDCs. But it can go further.
In particular, research on the monetary policy implications of CBDCs could benefit from greater clarity on how they interact with and affect financial market structures.14
Another topic which would benefit from further research, is the impact of CBDCs on ‘r-star’ – the neutral rate of interest. So far, findings are mixed. For instance, r-star could increase if CBDCs make payments more productive. But if CBDCs lead to more government bond purchases, term premia are affected – with unclear effects on r-star.
Research advances could also allow to gain further insights on the possible spillovers from the cross-border use of CBDCs, such as capital flight, exchange rate volatility, or even risks of digital dollarisation or euroisation (Ferrari et al. 2021).
That being said, most topics are at the intersection of monetary policy and financial stability. For example, further discussion of the approaches to calibrating CBDCs would be useful for both topics. How do we find the right balance of risks between too much and too little CBDC take-up? What are the implications of quantity constraints and tiered remuneration for the acceptance of CBDCs? What are the effects of the international use of CBDCs? For example, should safeguards be uniform for domestic and foreign users? What are the implications of differences in sectoral usage, such as between households and businesses? How do CBDCs interact with existing bank regulation and crisis management tools?
Another important research topic is the co-existence of CBDCs with stablecoins and cryptoassets. In particular, we should be mindful that the counterfactual to a world without CBDC is not the status quo. Rather it could be one that sees a diminished role of central bank money and a stronger one for stablecoins and crypto-assets with risks for monetary sovereignty, the lender of last resort functions of central banks and financial stability.
This list of open questions is not exhaustive, of course. But by continuing to focus on the right topics, CBDC research would also provide the conceptual backbone and evidence that could usefully inform future policy decisions on CBDCs.
Authors’ note: The opinions expressed in this column are our own and not necessarily those of the ECB.
Adalid, R, A Álvarez-Blázquez, L Burlon, M Dimou, C López-Quiles, N Martín, B Meller, M Muñoz, F Pennesi, P Radulova, G Šílová, O Soons and A Ventula (forthcoming) “Central bank digital currency and bank intermediation”, ECB Occasional Paper Series.
Chiu, J. et al. (2019), “Bank Market Power and Central Bank Digital Currency: Theory and Quantitative Assessment”, Staff Working Papers, No 2019-20, Bank of Canada, May.
Andolfatto, D (2020), “Assessing the Impact of Central Bank Digital Currency on Private Banks”, The Economic Journal, September.
Assenmacher, K, A Berentsen, C Brand and N Lamersdorf (2021), "A unified framework for CBDC design: remuneration, collateral haircuts and quantity constraints", Working Paper Series, No 2578, ECB, July.
Bindseil, U (2020), "Tiered CBDC and the financial system", Working Paper Series, No 2351, ECB, January.
Bindseil, U and F Panetta (2020), "Central bank digital currency remuneration in a world with low or negative nominal interest rates", VoxEU, 5 October.
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Chiu, J and F Rivadeneyra (2021), “Central bank digital currency, bank intermediation and payments”, in Niepelt, D. (ed.), Central Bank Digital Currency: Considerations, Projects, Outlook, CEPR Press.
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Committee on Payments and Market Infrastructures – Markets Committee (2018), “Central bank digital currencies”, March.
ECB (2020), Report on a digital euro, October.
Ferrari, M, A Mehl, F Panetta and I Van Robays (2021), “The international dimension of central bank digital currencies: Open research questions”, VoxEU, 19 October.
Garatt, R, J Yu and H Zhu (2022), "How Central Bank Digital Currency Design Choices Impact Monetary Policy Pass-Through and Market Composition", available at SSRN 4004341.
Ikeda, D (2021), “Digital money as a medium of exchange and monetary policy in open economies”, paper presented at the ASSA meetings, 7-9 January 2022.
International Group on CBDC (2021), "Central bank digital currencies: executive summary", 30 September.
Jiang, J and Y Zhu (2021), “Monetary Policy Pass-Through with Central Bank Digital Currency”, Staff Working Papers, No 2021-10, Bank of Canada.
Keister, T and C Monnet (2020), “Central Bank Digital Currency: Stability and Information”, Rutgers University and University of Bern, mimeo.
Keister, T and D Sanches (2019), “Should Central Banks Issue Digital Currency?”, Working Papers, No 19-26, Federal Reserve Bank of Philadelphia.
Kumhof, M and C Noone (2018), “Central bank digital currencies — design principles and balance sheet implications”, Staff Working Papers, No 725, Bank of England, May.
Li, J (2021), "Predicting the demand for central bank digital currency: a structural analysis with survey data", Bank of Canada, mimeo.
Monnet, C, A Petursdottir and M Rojas-Breu (2021), “Central Bank Account for All: Efficiency and Risk Taking”, Universities of Bern, Bath and Paris-Dauphine, mimeo.
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1 A wholesale CBDC, by contrast, would be available to financial institutions – not the general public. Data on the number of central banks exploring CBDCs are from https://www.atlanticcouncil.org/cbdctracker/.
2 As stressed, for instance, in Niepelt (2021).
3 New ECB staff analysis shows that the impact on the aggregate banking sector could be manageable overall, subject to safeguards and a high starting level of central bank reserves and liquidity buffers (see Adalid et al., forthcoming). Research by a group of central banks, including the ECB, also finds that the impacts of CBDCs on bank disintermediation and lending could be manageable for the banking sector (International Group on CBDC (2021)). These impacts would likely be limited for many plausible levels of CBDC take-up if the system had the time and flexibility to adjust.
4 Li (2021) uses Canadian survey data to estimate how different design features – such as usefulness for budgeting, anonymity, bundling of bank services and rate of return – would affect demand for CBDCs. Under his baseline design for a CBDC, households’ total CBDC holdings can range from 4% to 52% of their total liquid assets. Remuneration is found to be one of the most important attributes that affects the potential demand for CBDCs.
5 As suggested in Bindseil (2020) and Bindseil and Panetta (2020).
6 The point is also emphasised in, for example, Ikeda (2021).
7 See Chiu et al. (2022). This paper develops a micro-founded general equilibrium model of payments to study the impact of a CBDC on intermediation of private banks. If banks have market power in the deposit market, a CBDC can enhance competition, raising the deposit rate, expanding intermediation and increasing output.
8 One study shows that the mere presence of safe deposits in institutions other than banks played a significant role in triggering bank runs during the French Depression of 1930-31 (Monnet et al. 2021).
9 Adalid et al. (forthcoming) provide model simulations of bank runs under illustrative digital euro holdings and take-up scenarios. They also show that, if the supply of CBDC is constrained and depending on the calibration of usage limits and/or remuneration, a CBDC may in fact decrease the scale and speed of runs when compared with the scenario with no digital euro.
10 See Garatt et al. (2022). As the authors further stress, raising the remuneration rate of a CBDC may enhance monetary policy pass-through, but it has adverse consequences on market composition. By contrast, increases in the CBDC’s convenience value levels the playing field between banks, but also weakens the transmission of monetary policy. A CBDC with a sufficiently high convenience value can strengthen the transmission of monetary policy.
11 This would require funds in excess of users’ limits to be redirected to or from their commercial bank accounts (see ECB 2020).
12 Up to that threshold, CBDC holdings would never be subject to negative interest rates, ensuring that it is a means of payment that is as attractive as cash. In the case of the ECB, a digital euro would not be used as a monetary policy instrument and physical banknotes would continue to be issued (see Bindseil and Panetta 2020).
13 This point was stressed in ECB (2020) and elsewhere.
14 For example, do these interactions and effects vary between bank-based and capital market-based financial systems?