The likely impact of central bank digital currencies on quantitative easing

Many central banks are considering launching digital currencies. Far from a simple technological innovation, central bank digital currencies (CBDC) might persistently alter the size and composition of central bank balance sheets. Martina Fraschini, Luciano Somoza and Tammaro Terracciano analyse the equilibrium effects of the introduction of a CBDC and its interaction with current monetary policies. They show how and when issuing a CBDC might render expansionary policies quasi-permanent.

Major central banks are researching retail central bank digital currencies (CBDCs) and considering their introduction in the near future (BIS, 2020). A retail CBDC is defined as a digital payment instrument, denominated in the national unit of account, that is a direct liability of the central bank (BIS, 2020). Or, loosely speaking, it is a retail version of bank reserves.

Yet, how a CBDC would interact with existing monetary policy, and whether it could push the central bank towards riskier assets remain open issues (BOE, 2020). Allowing retailers to hold central bank deposits might considerably increase the size of the central bank balance sheet and pose the problem of which assets to hold against them. These questions are particularly relevant as central bank balance sheets, already at record levels after the global financial crisis, are pushed into further expansions by asset purchase programs aimed at mitigating the impact of COVID-19 (e.g. ECB’s pandemic emergency purchase programme (PEPP)).[1] While it would certainly be possible to use a CBDC to do helicopter money-like operations, the current working hypothesis for most CBDC projects is to hold assets against these new deposits. On this topic, the European Central Bank, in the report on the Digital Euro published in October 2020, explicitly states that

“…the issuance of a digital euro would change the composition and most likely the size of the Eurosystem’s balance sheet, and would therefore affect its profitability and risk exposure […] the Eurosystem would need to acquire assets (loans or securities) to be held against digital euro; (iii) unlike cash, a digital euro could be remunerated, which would affect seigniorage income”    (European Central Bank, Report on a Digital Euro, page 18, October 2020)

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