Fed report analyzes potential impact of CBDC on monetary policy

On Tuesday, the Federal Reserve released a study on the possible impact of a retail central bank digital currency (CBDC) on the conduct of U.S. monetary policy. The study, dated April, is a working paper titled "Retail CBDC and US Monetary Policy Implementation: A Stylized Balance Sheet Analysis."

The paper considers four scenarios from the perspective of three stakeholder groups (the Federal Reserve, commercial banks, and U.S. households) to illustrate the potential impact of a retail CBDC on monetary policy.

The first scenario is to exchange cash for CBDC, which affects the asset classification of the Fed and related households, but has no effect on policy implementation. The next three scenarios show a cascading effect, starting with individuals withdrawing CBDC deposited in cash from commercial banks.

Assuming that banks’ reserve requirements are fixed, the ensuing scenarios discuss commercial bank responses to reduced cash reserves resulting from CBDC withdrawals. If these withdrawals lead to insufficient reserves, banks may choose to sell certain securities or loans to increase their cash holdings again, or to increase deposits by offering more attractive product terms. This, in turn, could lead to higher short-term interest rates and reduce demand for CBDC by lengthening the maturity of bank deposits.

If rates rise too quickly, the Fed could turn to the discount window and standing repo facility to adjust rates, and if that fails, reserve management purchases would be the next step. This document discusses these technical operations in some detail.

According to the authors, the paper shows that “the potential impact of a retail CBDC on the conduct of monetary policy is highly dependent on the initial conditions of the Fed’s balance sheet.” Their analysis also sets out how the Fed could use existing tools to manage the impact of a retail CBDC on monetary policy. The impact of monetary policy implementation.

The document is the latest sign of a flurry of activity surrounding CBDCs in the United States and other countries.

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