Central Bank Digital Currencies - Benefits versus Costs Michael - - PowerPoint PPT Presentation

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Central Bank Digital Currencies - Benefits versus Costs

Michael Kumhof, Bank of England Co-authors: John Barrdear, Bank of England Clare Noone, Reserve Bank of Australia

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The Future of Money Conference, Frankfurt, November 24, 2018

Disclaimer

The views expressed herein are those of the authors, and should not be attributed to the Bank of England or the Reserve Bank of Australia.

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1 Introduction

• The emergence of the distributed ledger technology (DLT) and of Bitcoin

was a watershed moment in the history of ’e-monies’.

• It may, for the first time, be technically feasible for central banks to offer

universal access to their balance sheet. — Existing centralized RTGS systems: Not robust for universal access. — New decentralized DLT systems: Can potentially solve this problem.

• Question: Is universal access economically desirable.

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2 What is a Digital Currency?

• Traditional Electronic Payment Systems - Tiered Ledgers:

— Payments routed through and must be verified by specific third parties. — Third parties arranged in a hierarchical network.

• Digital Currencies - Distributed Ledgers:

— Payments are peer-to-peer and can be verified by multiple verifiers. — Verifiers arranged in a peer-to-peer network.

• Bitcoin - Distributed Ledger + Alternative Monetary System.

— BoE research rejects the monetary system of Bitcoin. — BoE research takes inspiration from its payment system.

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Maintaining the Ledger

• Suggested additions to the Bitcoin ledger are cheap talk:

Costless, non-binding and unverifiable.

• Bitcoin (cryptocurrencies) make proposed changes costly:

— Through a proof-of-work system. — Result: Over-investment in computing power. ∗ Bitcoin, by end-2018, will consume as much electricity as Netherlands! ∗ And cryptocurrency electricity consumption is growing fast.

• A permissioned system (e.g. CBDC) makes proposed changes binding:

— Transaction verifiers are regulated to ensure veracity. — Trust in central party replaces proof-of-work system.

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3 What is a Central-Bank Digital Currency (CBDC)?

• Access to the central bank’s balance sheet.
• Availability: 24/7.
• Universal: Banks, firms and households.
• Electronic: For resiliency reasons, probably using DLT.
• National-currency denominated: 1:1 exchange rate.
• Issued only through spending or against eligible assets: Government bonds.
• Interest-bearing:

— To equate demand and supply at 1:1 exchange rate. — Second tool of countercyclical monetary policy.

• Coexisting with the present banking system.

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4 The Model

4.1 Overview

• Based on Benes and Kumhof (2012) and Jakab and Kumhof (2015, 2018).
• The non-monetary model elements are standard New Keynesian fare.
• Households:

— Deposits: Created by banks through loans (see keynote this morning). — CBDC: Created by central bank, issued via OMO or spending/lending. — Deposits and CBDC jointly serve as medium of exchange.

• Banks: Create new deposits by making new loans.

— Loans are risky → banks can make losses. — Deposits reduce costs of transactions → can pay a lower interest rate.

• Government:

— Fiscal policy. — Traditional monetary policy. — CBDC monetary policy.

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4.2 Monetary Policy - The Policy Rate

it = (it−1)ii

• isteady state

(1−ii)   

πp

4,t+3

• πp

tgt

4   

(1−ii)iπp

4

• This is a standard forward-looking Taylor rule with interest rate smoothing.
• I show this to make sure that central bankers do not get nervous:

This is not a completely new world.

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4.3 Monetary Policy - CBDC

4.3.1 Quantity Rule for CBDC mrat

t

= mrat

tgtSms t

− 100mπpEt ln

  

πp

4,t+3

• πp

tgt

4   

• Fix the quantity of CBDC, let CBDC interest rate clear the market.
• mπp > 0: Removes CBDC from circulation in a boom.

4.3.2 Price Rule for CBDC im,t = it

sp

  

πp

4,t+3

• πp

tgt

4   

−im

πp

• Fix interest rate on CBDC, let the quantity of CBDC clear the market.
• im

πp > 0: Makes CBDC less attractive in a boom.

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5 Steady State Effects of the Transition to CBDC

• Assumptions:

— Issue CBDC against government debt. — Magnitude: 30% of GDP.

• Results:

Steady State Output Effect

• 1. Lower Real Policy Rates

+1.8%

• 2. Higher Deposit Rates Relative to Policy Rates
• 0.9%
• 3. Reductions in Fiscal Tax Rates

+1.1%

• 4. Reductions in Liquidity Tax Rates

+0.9% Total +2.9%

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The Main Factors Explained

• 1. Lower real interest rates:
• Assumption: CBDC issued against government debt.
• CBDC is not defaultable, government debt is.
• CBDC carries a lower interest rate than government debt.
• 2. Lower distortionary taxes:
• Much larger central bank balance sheet.
• Therefore much larger seigniorage flows.
• Also: Lower interest costs (see above).
• Assumption: Seigniorage is used to reduce distortionary taxes.
• 3. Lower transactions costs:
• Modern money is 95%+ created by private banks.
• This is costly: Spreads, regulation, bank market power, collateral.
• You can therefore never reach the Friedman rule.
• But with CBDC you can get much closer.

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5 10 15 20 25 30 5 10 15 20 25 30

• 4 0 4 8 12162024283236404448525660

CBDC/GDP

(pp Difference)

• 30
• 25
• 20
• 15
• 10
• 5
• 30
• 25
• 20
• 15
• 10
• 5
• 4 0 4 8 12162024283236404448525660

Privately Held Gov. Debt/GDP

(pp Difference)

• 2

2 4

• 2

2 4

• 4 0 4 8 12162024283236404448525660

Bank Deposits/GDP

(pp Difference) 0.0 0.5 1.0 1.5 2.0 2.5 0.0 0.5 1.0 1.5 2.0 2.5

• 4 0 4 8 12162024283236404448525660

GDP

(% Difference) 0.0 0.5 1.0 1.5 2.0 0.0 0.5 1.0 1.5 2.0

• 4 0 4 8 12162024283236404448525660

Consumption

(% Difference) 1 2 3 4 5 1 2 3 4 5

• 4 0 4 8 12162024283236404448525660

Investment

(% Difference) 0.0 0.2 0.4 0.6 0.8 0.0 0.2 0.4 0.6 0.8

• 4 0 4 8 12162024283236404448525660

Inflation Rate

(pp Difference) 2.4 2.6 2.8 3.0 2.4 2.6 2.8 3.0

• 4 0 4 8 12162024283236404448525660

Real Policy Rate

(Level p.a.) 3.8 4.0 4.2 4.4 3.8 4.0 4.2 4.4

• 4 0 4 8 12162024283236404448525660

Average Real Wholesale Rate

(Level p.a.)

• 0.3
• 0.2
• 0.1

0.0

• 0.3
• 0.2
• 0.1

0.0

• 4 0 4 8 12162024283236404448525660

Consumption Tax Rate

(pp Difference)

• 1.5
• 1.0
• 0.5

0.0

• 1.5
• 1.0
• 0.5

0.0

• 4 0 4 8 12162024283236404448525660

Labor Tax Rate

(pp Difference)

• 1.2
• 1.0
• 0.8
• 0.6
• 0.4
• 0.2

0.0

• 1.2
• 1.0
• 0.8
• 0.6
• 0.4
• 0.2

0.0

• 4 0 4 8 12162024283236404448525660

Capital Tax Rate

(pp Difference)

• 0.8
• 0.6
• 0.4
• 0.2

0.0

• 0.8
• 0.6
• 0.4
• 0.2

0.0

• 4 0 4 8 12162024283236404448525660

Consumption Liquidity Tax

(pp Difference)

• 0.10
• 0.05

0.00

• 0.10
• 0.05

0.00

• 4 0 4 8 12162024283236404448525660

Production Liquidity Tax

(pp Difference)

• 1.5
• 1.0
• 0.5

0.0

• 1.5
• 1.0
• 0.5

0.0

• 4 0 4 8 12162024283236404448525660

Investment Liquidity Tax

(pp Difference)

Transition to Steady State with CBDC solid line = actual transition ; dotted line = change in long-run steady state 3

Lower Fiscal Taxes Lower Liquidity Taxes Lower Interest Rates

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6 Quantity Rules or Price Rules for CBDC?

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• 1.4
• 1.2
• 1.0
• 0.8
• 0.6
• 0.4
• 0.2
• 0.0
• 1.4
• 1.2
• 1.0
• 0.8
• 0.6
• 0.4
• 0.2
• 0.0
• 4

4 8 12 16 20 24 28 32

GDP

(% Difference)

• 1.2
• 1.0
• 0.8
• 0.6
• 0.4
• 0.2

0.0

• 1.2
• 1.0
• 0.8
• 0.6
• 0.4
• 0.2

0.0

• 4

4 8 12 16 20 24 28 32

Inflation Rate

(pp Difference) 2.2 2.4 2.6 2.8 3.0 3.2 2.2 2.4 2.6 2.8 3.0 3.2

• 4

4 8 12 16 20 24 28 32

Real Policy Rate

(Level p.a.) 2 4 6 8 10 2 4 6 8 10

• 4

4 8 12 16 20 24 28 32

Bank Deposits/GDP

(pp Difference) 2 4 6 8 10 2 4 6 8 10

• 4

4 8 12 16 20 24 28 32

Bank Loans/GDP

(pp Difference) 5.0 5.5 6.0 6.5 5.0 5.5 6.0 6.5

• 4

4 8 12 16 20 24 28 32

Average Real Retail Lending Rate

(Level p.a.) 1.8 1.9 2.0 2.1 2.2 2.3 2.4 1.8 1.9 2.0 2.1 2.2 2.3 2.4

• 4

4 8 12 16 20 24 28 32

Spread: Policy Rate minus CBDC Rate

(Level p.a.) 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5

• 4

4 8 12 16 20 24 28 32

CBDC/GDP

(pp Difference) 0.0 0.5 1.0 1.5 2.0 2.5 0.0 0.5 1.0 1.5 2.0 2.5

• 4

4 8 12 16 20 24 28 32

Average Liquidity Tax

(pp Difference)

Shock to Demand for Total Liquidity solid line = quantity rule ; dotted line = price rule 4

Liquidity demand is mostly satisfied by instantaneous creation of bank deposits through loans. But CBDC can help. The Poole (1970) effect whereby Q rules are worse than P rules is weak.

Price Rule Quantity Rule

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7 Countercyclical CBDC Rules

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• 2.0
• 1.5
• 1.0
• 0.5

0.0 0.5 1.0

• 2.0
• 1.5
• 1.0
• 0.5

0.0 0.5 1.0

• 4

4 8 12 16 20 24 28 32

GDP

(% Difference)

• 1.5
• 1.0
• 0.5

0.0 0.5 1.0 1.5 2.0

• 1.5
• 1.0
• 0.5

0.0 0.5 1.0 1.5 2.0

• 4

4 8 12 16 20 24 28 32

Inflation Rate

(pp Difference) 2 3 4 5 6 7 8 9 2 3 4 5 6 7 8 9

• 4

4 8 12 16 20 24 28 32

The Policy Rate Corridor

(Level p.a.)

• 10
• 5

5 10

• 10
• 5

5 10

• 4

4 8 12 16 20 24 28 32

CBDC/GDP

(pp Difference)

Bottom Left: Nominal Policy and CBDC Rates Solid Line = Policy Rate, Dotted Line = Policy Rate minus Fixed Spread, Dashed Line = CBDC Rate

Credit Cycle Shock - Price Rule - Policy Rate Corridor

Countercyclical CBDC policy would lower the CBDC rate relative to the policy rate in a boom, and vice versa in a bust.

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• 2
• 1

1

• 2
• 1

1

• 4

4 8 12 16 20 24 28 32

GDP

(% Difference)

Credit Cycle Shock - CBDC Countercyclical Price Rule

• Solid line = fixed rule
• Dashed line = c'cyclical rule
• Dotted line = aggressive rule

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8 Financial Stability: CBDC Bank Runs?

• Bank-deposits-to-CBDC run difficult in aggregate. 2 reasons:
• 1. Aggregate increases in CBDC demand do not affect bank deposits:

— Central bank sells CBDC only against government debt. — Not against bank deposits: No unconditional LoLR guarantee. — CBDC purchases among non-banks are irrelevant for deposits.

• 2. CBDC policy rules can further discourage volatile CBDC demand.

— Quantity rule: ∗ CBDC supply fixed, CBDC interest rate clears the market. ∗ Lower political bound on CBDC rate? Switch to price rule. — Price rule: ∗ CBDC supply endogenous, CBDC quantity clears the market. ∗ Running out of government bonds? Switch to other securities.

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• Kumhof and Noone (2018): Four Key Design Principles for CBDC
• 1. CBDC pays an adjustable interest rate:

— To clear the market under a quantity rule. Without large balance sheet or price level fluctuations. — As countercyclical tool under an interest rate rule.

• 2. CBDC and reserves are distinct, and not convertible into each other:

— To keep control of the quantity of reserves and the policy rate. — This also prevents deposits-to-CBDC runs through the back door.

• 3. No on-demand convertibility of bank deposits into CBDC:

— Convertibility at commercial banks requires CB support. — It thus requires convertibility at the CB. — This is a guarantee of unlimited and unsecured LoLR. — It opens the door wide to system-wide bank runs.

• 4. CB only issues CBDC against eligible securities:

— Principally government securities. — This is standard practice for issuance of government money today.

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• The final two principles imply that:

— Agents can freely trade deposits against CBDC in a private market. — Private market can freely obtain additional CBDC at the CB. — But only: ∗ At the posted CBDC interest rate. ∗ Against eligible securities.

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9 Conclusions

• CBDC has significant benefits =

⇒ further research is worthwhile.

• 1. Steady state efficiency:
• Lower interest rates, higher seigniorage, more and cheaper liquidity.
• Increase in steady-state GDP could be as much as 3%.
• 2. Business cycle stability:
• Second policy instrument.
• Improved ability to stabilize inflation and the business cycle.
• 3. Financial stability:
• CBDC should reduce many financial stability risks.
• But if it is not designed well it may introduce others.
• The “run risk” can be mostly eliminated by sound system design.
• Critical issue: Design of a smooth transition.

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Thank you!