Monetary Policy Pass-Through with Central Bank Digital Currency

Many central banks are considering issuing a central bank digital currency (CBDC). This would introduce a new policy tool—interest on CBDC. We investigate how this new tool would interact with traditional monetary policy tools, such as the interest on central bank reserves. 

We build  a model in which CBDC and bank deposits are perfect substitutes as electronic payment methods. We discuss the effects (or pass-through) of two monetary policy tools: the interest on reserves and the interest on CBDC. Specifically, we examine how, in the presence of each other, these two policy tools affect the rates and quantities of deposits and loans.

We find that when it is in effect, the interest on CBDC fully dictates the deposit rate and eliminates the pass-through from the interest on reserves to the deposit rate. How the interest on CBDC affects the pass-through from the interest on reserves to other economic variables depends on the market structure of the deposit market. While CBDC tends to weaken the pass-through of the interest on reserves when banks have market power, the reverse holds when the market is competitive. In turn, a high interest on reserves may weaken the pass-through of the interest on CBDC. In general, coordination between the two policy rates is needed to effectively achieve policy goals.