Central Bank Digital Currency (CBDC) Policy

A CBDC allows central banks to apply differentiated interest rates directly to the digital currency, enabling targeted monetary policy. This could involve:

• Tiered remuneration: Applying negative rates to large holdings to discourage hoarding, while keeping rates positive for general use.
• Sector-specific rates: Offering preferential rates to funds held for specific purposes, like green investments.
• Automated implementation: Changes to rates can be propagated instantly across the entire monetary base.

These tools are designed to stimulate spending and increase the velocity of money by imposing a cost on holding idle CBDC balances.

• Expiring digital cash: Implementing a 'use-by' date, after which the currency loses value, forcing holders to spend or invest it.
• Demurrage charges: Applying a small, periodic negative interest rate that automatically reduces balances over time.
• Policy goal: To combat deflationary spirals and liquidity traps by making saving in CBDC less attractive than consumption or investment.

CBDCs enable the direct and instantaneous transfer of funds from the central bank to citizens' digital wallets, bypassing commercial banks. This tool allows for:

• Precise targeting: Transfers can be made to specific demographics, regions, or income brackets.
• Conditional disbursements: Funds can be programmed for use only on certain goods (e.g., essentials) or within a time window.
• Crisis response: Rapid deployment of stimulus during economic shocks, with full visibility into uptake and spending.

A CBDC provides an unprecedented, high-resolution view of the economy's monetary flows in real-time, enhancing policy decision-making.

• Aggregate data: Instant visibility into spending, saving, and velocity patterns across the entire economy.
• Granular analytics: Ability to analyze economic activity by sector, region, or transaction size without individual privacy breaches.
• Forward guidance: Data informs more accurate forecasts and allows for faster, evidence-based adjustments to policy levers.

Central banks can use the CBDC infrastructure to influence the allocation of credit in the economy more directly.

• Digital collateral: CBDC can be used as high-quality, programmable collateral in secured lending markets.
• Sectoral quotas: Implementing limits or incentives on bank lending to specific sectors (e.g., real estate) by adjusting the conditions for bank access to CBDC liquidity.
• Transmission mechanism: Strengthens the pass-through of policy rates to bank lending rates by controlling the core settlement asset.

CBDC tools differ fundamentally from conventional monetary policy instruments like Open Market Operations (OMOs) and Reserve Requirements.

• Precision: Targets end-users directly, not just commercial bank reserves.
• Speed: Policy changes are software-defined and can be enacted near-instantly.
• Transmission: Reduces reliance on the bank lending channel, potentially making policy more effective at the Zero Lower Bound (ZLB).
• New trade-offs: Introduces complex considerations around financial disintermediation, privacy, and financial stability.

A core design choice is the access model. A retail CBDC is issued directly to the public, acting as a digital form of cash and potentially disintermediating commercial banks. A wholesale CBDC is restricted to financial institutions for settling interbank payments and securities transactions, enhancing existing systems without altering public access. The People's Bank of China's digital yuan (e-CNY) is a leading example of a retail model, while the Bank of Japan's Project Stella experiments with a wholesale design.

The underlying technology stack is a critical trade-off. A centralized ledger, managed solely by the central bank, offers maximum control and simplicity but may lack resilience and innovation speed. A permissioned distributed ledger technology (DLT) network, where approved nodes (e.g., banks) validate transactions, can increase system resilience and enable programmable features but introduces complexity in governance and integration. The European Central Bank's digital euro investigation is evaluating both architectural approaches.

Balancing user privacy with Anti-Money Laundering (AML) and Counter-Financing of Terrorism (CFT) requirements is a paramount policy challenge. Design options include:

• Token-based anonymity: Mimicking cash for small-value transactions.
• Account-based identity: Tying holdings to verified identities for larger amounts.
• Tiered privacy models: Offering varying anonymity levels based on transaction size or user verification status. The Swedish Riksbank's e-krona project has explicitly prioritized designing for high privacy while meeting regulatory obligations.

A CBDC must integrate with the current financial ecosystem. Key considerations include:

• Technical interoperability: APIs and standards for seamless connection with bank core systems, payment processors, and digital wallets.
• Cross-border interoperability: The ability to transact with other CBDCs or foreign payment systems, a focus of the Bank for International Settlements (BIS) Project mBridge.
• Legal interoperability: Ensuring the CBDC's legal status is clear within existing frameworks for payments, insolvency, and contract law.

A poorly designed CBDC could threaten financial stability. In a crisis, the public might rapidly convert bank deposits into a perceived safer CBDC, causing bank runs and reducing credit availability (disintermediation). Mitigations include:

• Holding limits: Capping individual CBDC balances.
• Tiered remuneration: Applying negative interest rates to large holdings to discourage use as a savings vehicle.
• Intermediated models: Where commercial banks manage customer CBDC accounts, preserving their role.

A digital currency enables new programmable money features. This could allow for:

• Expiration or holding conditions: To stimulate spending (e.g., pandemic relief funds).
• Direct implementation of monetary policy: Such as applying negative interest rates directly to CBDC holdings.
• Smart contract automation: For conditional payments in trade finance or subsidies. These capabilities raise significant questions about central bank overreach, economic freedom, and the technical complexity of monetary implementation.

A core policy distinction is between wholesale CBDCs, restricted to financial institutions for interbank settlements, and retail CBDCs, accessible to the general public and businesses.

• Wholesale: Primarily aims to improve payment system efficiency and securities settlement (e.g., Project Jasper, Canada).
• Retail: Aims for financial inclusion, resilience, and providing a public digital payment option (e.g., the digital yuan e-CNY, Bahamas Sand Dollar).

This technical design choice has major policy implications for privacy, access, and offline functionality.

• Account-Based: Ties ownership to a verified identity at a financial institution or the central bank, similar to a bank account. Enables easier monetary policy transmission but raises privacy concerns.
• Token-Based: Ownership is proven by cryptographic possession of a digital token, enabling more peer-to-peer transactions and potential for programmable money. This model can support greater privacy but complicates AML/CFT compliance.

While both are digital assets pegged to a fiat currency, their issuer and legal status are fundamentally different.

• CBDC: A direct liability of the central bank, representing sovereign money with full legal tender status. Its value and stability are backed by the state.
• Stablecoin: A liability of a private entity (e.g., Tether, Circle). It is not legal tender and its stability depends on the quality and transparency of its reserve assets and the issuer's solvency.

CBDCs differ from the digital bank balances we use today, which are commercial bank money.

• CBDC: A direct claim on the central bank's balance sheet, carrying no credit or liquidity risk from a commercial bank.
• Commercial Bank Deposits: A claim on a private bank. These deposits are protected by deposit insurance but are subject to bank insolvency risk. A CBDC could, in theory, reduce demand for such deposits, a phenomenon known as disintermediation.

A key policy debate centers on how CBDCs could transform monetary policy transmission.

• Direct Tools: Could enable central banks to implement helicopter money or apply negative interest rates directly to CBDC holdings to stimulate spending.
• Financial Stability: Rapid shifts from bank deposits to CBDC in a crisis (digital bank run) could destabilize the banking system, necessitating design features like tiered remuneration or holding limits.

The design of a CBDC's transaction ledger is a critical policy decision balancing privacy rights with regulatory requirements.

• Centralized Ledger: The central bank sees all transaction data, enabling powerful anti-money laundering (AML) oversight but creating unprecedented financial surveillance capabilities.
• Privacy-Enhancing Technologies (PETs): Policies may explore the use of zero-knowledge proofs or anonymity vouchers to allow for small, anonymous transactions while maintaining oversight for larger ones.