Digital Money and Central Bank Operations

Digital Money and Central Bank Operations Charles Kahn, Manmohan Singh, and Jihad Alwazir WP/22/85 © 2022 International Monetary Fund WP/22/85IMF Working Paper Monetary and Capital Markets Department Digital Money and Central Bank Operations Charles Kahn, Manmohan Singh, and Jihad Alwazir May 2022 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. ABSTRACT: The rise of new and proposed monetary vehicles, including CBDC, stablecoins, payment service providers etc., are unprecedented. An important question for central banks is the extent to which these innovations upend the role of and implementation of monetary policy. The paper focuses on the interest rate channel and if digital money (especially CBDC) will change monetary policy and central bank operations. We argue that new policy instruments make sense only to the extent that there is limited substitutability between the various payment sectors. We analyze trends in currency-in-circulation, and how it may impact central bank’s seigniorage, monetary base, and transactional velocity of digital money if money demand declines. Liquidity outside the monetary base will also be important to understand. JEL Classification Numbers: E5; E41; G15; F30 Keywords: Base money; CBDC; central banking operations; currency in circulation; digital money; mobile phone operators; seigniorage. Author’s E-Mail Address: cmkahn@illinois.edu; msingh@imf.org; jalwazir@imf.org IMF WORKING PAPERS Digital Money and Central Bank Operations INTERNATIONAL MONETARY FUND 0 WORKING PAPERS Digital Money and Central Bank Operations Prepared by Charles Kahn, Manmohan Singh, and Jihad Alwazir1 1 The authors would like to thank Peter Stella, Karl Habermeier, Simon Gray, and Adrian Armas for comments. Authors are responsible for any errors. IMF WORKING PAPERS Digital Money and Central Bank Operations INTERNATIONAL MONETARY FUND 1 Contents Introduction ......................................................................................................................................................... 2 I. Payments Assets, Old and New ...................................................................................................................... 3 II. Interest Rate Channel ..................................................................................................................................... 6 III. New Instruments for Other Goals ................................................................................................................. 7 IV. Central Bank Operational Issues ................................................................................................................. 8 V. Payment Service Providers and Demand for Money ................................................................................. 13 VI. Conclusion ................................................................................................................................................... 16 References ......................................................................................................................................................... 18 BOXES 1. Types of Central Bank Digital Currency ....................................................................................................... 4 2. Stablecoins are Money if Backed by Central Bank Reserves ..................................................................... 5 3. Demand for Money and Seigniorage ........................................................................................................... 11 4. Demand for Money and Sterilization ........................................................................................................... 13 FIGURES 1. Seigniorage and Base Money Changes ...................................................................................................... 10 2. Currency in Circulation and Monetary Base—Trends (2007-2020) .......................................................... 12 IMF WORKING PAPERS Digital Money and Central Bank Operations INTERNATIONAL MONETARY FUND 2 Introduction The rise of new and proposed monetary vehicles, including central bank digital currency (CBDC), stablecoins, payment service providers (e.g., mobile network operators), etc., means an unprecedented change in the retail and wholesale payments system. At the same time, central banks and infrastructure providers are examining new ways to facilitate transfer of value across wholesale payments platforms. An important question for central banks is the extent to which these innovations upend the role of and implementation of monetary policy. On the one hand, it can be argued that while the changes the