Will Interest-Bearing Central Bank Digital Currencies Benefit Open Economies?

Ammu George – Asia Competitiveness Institute, Lee Kuan Yew School of Public Policy, National University of Singapore;

Taojun Xie – Asia Competitiveness Institute, Lee Kuan Yew School of Public Policy, National University of Singapore;

Joseph D.Alba – School of Social Sciences, Nanyang Technological University

-- Many central banks across the world are toying with the idea of introducing central bank digital currency (CBDC) in the foreseeable future. China is expected to launch CBDC (digital Yuan) soon as a response to Facebook's proposed digital currency, Libra. Small open economies like Singapore, Sweden, Thailand, Turkey and Uruguay have already taken concrete steps or announced their intentions to launch a CBDC in the future. Countries like Japan and Australia, who were initially hesitant to CBDC implementation, are now experimenting with the feasibility of CBDC.

CBDC is defined by Barrdear and Kumhof (2016) in a working paper released by the Bank of England as “... a universally accessible and interest-bearing central bank liability, implemented via distributed ledgers, that competes with bank deposits as medium of exchange....”. Along with the technological innovations surrounding the payment infrastructure, the interest-bearing feature of CBDC constitutes the main economic innovation. An interest rate on CBDC provides policy makers with greater flexibility in stimulating economic activities. Kumhof and Noone (2018) highlight that an “adjustable interest rate” on CBDC, among other design principles, is imperative to satisfy the policy objectives of the central bank. The extent to which an adjustable interest on central bank money will improve the policy outcomes and welfare of residents, however, remains unclear.

To this end, our paper, entitled “Central Bank Digital Currency with Adjustable Interest Rate in Small Open Economies”, studies the macroeconomic and welfare implications of interest-bearing CBDC in an economy that is open to trade and capital flows. We use a dynamic stochastic general equilibrium model where fiscal, monetary and CBDC tools are used to achieve policy objectives. This model allows us to easily toggle between a CBDC with a constant return, e.g. 0 per cent, and one with an adjustable interest rate following either a price rule that specifies the response of the nominal CBDC interest rate, or a quantity rule that specifies the response of the quantity of CBDC supply to macroeconomic conditions. Through simulations, we show that the added flexibility due to the adjustable CBDC interest is welfare-improving, especially in the presence of foreign shocks. We also find that there are uneven distributional effects between the ‘holders’ and ‘non-holders’ of CBDC.

Our work contributes to the emerging literature of CBDC in four aspects.

  • First to formally examine the interest-bearing feature of CBDC in an open economy context.

  • Assesses the welfare implications of CBDC policy frameworks.

  • Studies the dynamic effects of CBDC on other assets such as bank deposits, bank loans and government securities.

  • Documents that the independence of CBDC regimes depends on its substitutability with bank deposits (the other medium of exchange).

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