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The Central Bank Digital Currency And Monetary Policy Framework

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This article will throw some lights on the perspective of the monetary policy objective and CBDC. One of the basic assumption I made in this article is that the CBDC is universally accessible and no assumptions on transaction limits. The widespread adoption of alternative means of payment not denominated in the domestic currency would weaken the transmission of monetary policy because the central bank would have influence on a smaller portion of the economy. This consideration is particularly important if the suppliers of the alternative means of payment have interests that are not in line with the objectives of the central bank. In such a case, the central bank may be forced to respond to the policy of the supplier of alternative means of payment. This could increase the constraints and reduce the effectiveness of central bank monetary policy. A CBDC, if it is appropriately designed, could counter the adoption of alternative means of payment. The wide adoption of new means of payment denominated in the domestic currency would not threaten the central bank’s ability to implement monetary policy—even if this adoption were accompanied by a decline in the demand for cash. With or without cash in circulation, monetary policy can be implemented as long as payment providers demand the settlement asset controlled by the central bank.

Central banks around the world have instituted real-time gross settlement (RTGS) systems over the past decades. A growing number of jurisdictions have introduced retail Faster Payments Service (FPS), which allow instant settlement of payments between households and businesses around the clock. FPS also support a vibrant ecosystem of banks and non-bank payment service providers, for examples the Unified Payments Interface (UPI) in India. Demands on retail payments are changing, with fewer cash transactions and a shift towards digital payments, in particular since the start of the Covid-19 pandemic.

Digital Currency

Many central banks are actively engaged in work on CBDCs as an advanced representation of central bank money for the digital economy. The foundation of the monetary system is trust in the currency. As the central bank provides the ultimate unit of account, that trust is grounded on confidence in the central bank itself. Central banks are accountable public institutions that play a pivotal role in payment systems, both wholesale and retail. They supply the ultimate means of payment for banks (bank reserves), and a highly convenient and visible one for the public (cash). Moreover, in their roles as operators, overseers and catalysts, they pursue key public interest objectives in the payments sphere: safety, integrity, efficiency and access.

According to me, CBDCs are best designed as part of a two-tier system, where the central bank and the private sector each play their respective role. A logical step in their design is to delegate the majority of operational tasks and consumer-facing activities to commercial banks and non-bank Payment Service Providers (PSP) that provide retail services on a competitive level playing field. Meanwhile, the central bank can focus on operating the core of the system. It guarantees the stability of value ensures the elasticity of the aggregate supply of money and oversees the system’s overall security.

Depending on the specifics of the design of CBDC there could have several consequences on monetary policy implementation. I will highlight three crucial dimensions to consider before launching of the CBDC in any jurisdiction: liquidity configuration, policy rates and access to central bank balance sheet. The design of the CBDC should ensure that any risk of sudden large shifts from bank deposits to CBDC would be avoided. It could still substitute a limited part of retail deposits, through an increase of what we call in central banking jargon “autonomous factors”, i.e. an item not linked to monetary policy but affecting the liquidity situation of the banking system. A liquidity-providing or liquidity-absorbing operations would need to remain available at any time to ensure that central banks can choose to operate in the monetary policy implementation framework they choose, even in the case of the launch of a CBDC. A successful CBDC should be attractive enough to be used by households and firms in their everyday payments. However, it should avoid the above-mentioned risk of excessive shifts from bank deposits to CBDC accounts, which would involve unwanted bank disintermediation and a possible destabilisation of the financial system. A balance must be found to meet both goals. A model would involve no limit on CBDC holdings amount, but a differentiated remuneration rate beyond a certain threshold (a so-called “tiered CBDC remuneration”), which would disincentives large CBDC holdings. A new remuneration rate should be articulated with the current key policy interest rates and whether there could be a case for changing some CBDC parameters together with central bank key policy rates. Depending on its attractiveness and detailed specifications, a CBDC could trigger a demand from financial actors, which usually do not have access to central bank money (mutual funds, insurance companies -) to be able to settle in CBDC. This could also raise questions related to modalities of access to central bank balance sheet. As central banks, in the context of monetary and financial stability mandate, it has a role to play to make sure that digitalisation becomes a blessing and not a curse. The readiness to issue a CBDC can prove an important lever to that end.

Contributed by –


Dr.Chiragra Chakrabarty

([email protected])


*The views expressed are personal.

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