Guest Contribution: “Central Bank Digital Currency: Some Macro-Financial Implications”

Today we are pleased to present a guest contribution written by Hongyi Chen, Senior Advisor at the Hong Kong Institute for Monetary and Financial Research, and Pierre Siklos, Professor of Economics at Wilfrid Laurier University. The views expressed here are their own and do not reflect the official opinions of Hong Kong Institute for Monetary Research or any other institutions the authors are affiliated with.

Recent history will partly be remembered as disruptive because of a series of crises, two financial in nature and one health related, occurring at a time of rapid growth in computing technology. This is exemplified by the proliferation and growing sophistication of various forms of electronic payments. Yet, monetary authorities around the world were reluctant to become directly involved until discussions turned to asking whether ‘money’ might eventually be issued digitally. From these discussions emerged increased focus on central bank digital currency (CBDC).


In our study, we are interested in a digital currency issued by the central bank that complements the traditional role of supplying notes and coins in circulation. More precisely, we are interested in the macroeconomic impact of CBDC that might be used by the general public (we do not consider the case of cryptocurrencies). A bone of contention is the impact of CBDC on the conduct of monetary policy and the monetary transmission mechanism. Some observers contend CBDC take central banks more deeply into the realm of fiscal policy and credit allocation as well as serving as a vehicle to overcome the zero lower bound (ZLB) of interest rates a few central banks have already breached.


There has been a proliferation of papers dealing with the practical, technical, and legal issues surrounding the introduction of CBDC, as well as some theoretical studies that examine the hypothetical financial and macroeconomic impact of CBDC. One section is devoted to reviewing the wide array of issues raised by the potential introduction of CBDC. Many have been covered in a rapidly growing literature which is summarized in the paper. However, we do highlight one aspect that has been greatly under-emphasized. Most studies tend to ignore or downplay the problem of data storage. Digital forms of payment require that balances in CBDC be stored somewhere. The idea of centralizing such storage raises all sorts of risks, from privacy to security, but even if storage is decentralized the sheer potential size of storage required, not to mention its durability, are details that have not been adequately addressed to date (we provide an example of where this problem has emerged in the field of physics). These considerations, combined with the form of CBDC that is eventually introduced (i.e., token or account based), will also influence how CBDC impacts the money supply.


We rely on historical data to consider the range of inflationary effects of the most likely forms of CBDC to be introduced by the major central banks in the foreseeable future. In doing so, we generate counterfactuals using McCallum’s monetary policy rule because it is unencumbered by the ZLB and it also has the virtue of shifting focus to the central bank’s balance sheet. McCallum’s rule, which can be specified for any definition of a monetary aggregate, links money growth to notional nominal GDP growth, the velocity of money, and an adjustment component for deviations of observed from targeted nominal GDP growth. McCallum’s rule is used to simulate scenarios of different monetary policy stances in an environment where financial innovations take place. We rely on the history of rapid technological developments in transactions technologies to determine hypothetical future inflation paths and consequences for money growth.


As a starting point an argument can be made that CBDC may have an impact likened to the fallout from previous eras of financial innovations. However, it is quite possible that existing regulations, or the failure to adapt to a changing financial landscape, a fairly reliable interpretation of financial history, may also generate changes in finance that have yet to be contemplated. The combined impact of developments referred to above would show up at least in part in a shift away from some types of deposits in banking institutions.


Our estimates for several advanced economies suggest that, even with financial innovations, the gap between observed and simulated money growth explains inflation movements quite well. When McCallum’s rule is simulated, conditional on a hypothetical view of the behaviour of velocity under conditions of financial innovation, in most cases the range of simulated estimates encompass observed money growth. The example below for the USA, illustrates the hypothetical range of money growth (M0 or M3) with CBDC under McCallum’s rule. The rule also provides, partly by construction, less volatile money growth than what has actually been observed. We conclude that CBDC need not impair inflation control regardless of the chosen monetary aggregate. We also examine the conditional volatility of money growth, under McCallum’s rule, in a CBDC regime. Our findings are that, even if CBDC are introduced, these need not prevent episodes associated with major financial crises from emerging that show up in the form of volatile money growth. Of course, our simulations are unable to capture novel ways policy makers might react to future crises as the results are conditioned on past history.

Figure 1: Hypothetical Money Growth with CBDC Using McCallum’s Rule


This post written by Hongyi Chen and Pierre Siklos.