The Implications of Retail CBDCs for Monetary Policy

Agenda
• There have been a lot of discussions on Wholesale CBDC,
the possible technical features and the design thinking
behind the new digital currency/electronic payment
system.
• There are few discussions on Retail CBDC on monetary
policy, with the exception of a number of papers by
academics, as well as white paper and technical papers
published by BIS, PBoC, HKMA and BoT.
• We intend to focus on the monetary economics, especially
in relation to an open economy, some recent
developments, as well as the implications of some
significant technical features.
• As the possibilities are aplenty, we posed certain
questions related to monetary policy with the use of
nascent technologies such as DLT, Smart Contacts and
DeFi (Decentralized Finance).

CONTENTS
01 02
03 04
Introduction of federal
reserve and money supply.
Introduction of Monetary Policy
Hong Kong Model What About Singapore?
Introduction of CBDC
All About CBDC
Beyond Monetary Policy
05

Introduction of Monetary Policy

01 Introduction of Monetary Policy
• Objective - Ensuring economic and
financial stability
• Targets - Maximum employment, and/or
low and stable inflation.
• Framework - Support liquidity in key
financial markets and maintain the flow of
credit.
• Policy tools - Money Supply, Interest Rate
(Long and Short Term), Reserve Ratio,
Open Market Operations.
Traditional Monetary Policy

M0
M1
M2
M1 plus savings deposits, small-
denomination time deposits (those
issued in amounts of less than
$100,000), and retail money market
mutual fund shares.
The sum of currency held by the
public and transaction deposits
at depository institutions
(which are financial institutions
that obtain their funds mainly
through deposits from the
public, such as commercial
banks, savings and loan
associations, savings banks, and
credit unions).
The sum of currency in circulation
and reserve balances (deposits held
by banks and other depository
institutions in their accounts at the
Federal Reserve).
Federal Reserve:
The money supply is the total amount of money: cash, coins, and balances in bank accounts — in
circulation.
https://www.federalreserve.gov/faqs/money_12845.htm

Previously, the money supply has exhibited close
relationships with important economic variables such
as GDP and the price level.
Central banks have at times used measures of the
money supply as an important guide in the conduct of
monetary policy.
Since 2008, however, the relationships have been quite
unstable.
As a result, the importance of the money supply as a
tool for the conduct of monetary policy in many
countries has diminished over time.
Money Supply Alone Is Not Sufficient
https://www.federalreserve.gov/faqs/money_12845.htm

Liquidity Trap and
Policy Impotency
Purchase of LT
bonds resulting in
zero or negative ST
interest rates
Liquidity Crunch
and Asset Price
Inflation
Asset Price
Inflation with huge
central bank
balance sheet
Foreign
Exchange Risk
Stress in currency
and local bond
markets due to
COVID-19
Systematic
Vulnerabilities
A dedicated policy
process is needed to
operationalize new
policy function: Micro
and Macro Prudential
Challenges
https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/20/Monetary-Policy-and-Central-Banking

Nominal (Policy) Rate
= LR Real Rate
+ f (LR inflation gap
and LR output gap)

Alter the Nominal Rates when potential output and inflation
deviate from long term rates.
Large Negative Rates! Prescriptions not working as well.
Assets Inflation is secondary but a challenge.

• Simple rules for the policy rate do not explicitly recognize
that the monetary policy toolkit includes other tools—
notably, large-scale asset purchases and forward
guidance, which are especially relevant when the policy
rate is constrained by the Effective Lower Bound (ELB).
• ELB refers to the point at which further cuts in the main
monetary policy interest rate no longer provide stimulus
to aggregate demand and GDP or at which adverse
effects, such as in the financial sector, where financial
asset prices can rise.
• For many countries in recent years and especially in the
aftermath of the 2007-2010 Global Financial crisis and
NOW, policy interest rates have been set well below the
equilibrium interest rate to provide support to demand,
output and jobs and reduce the risks of deflation.
Effective Lower Bound
https://www.federalreserve.gov/monetarypolicy/2021-07-mpr-part2.htm

https://www.federalreserve.gov/monetarypolicy/2021-07-mpr-part2.htm
Injecting liquidity by other means: Reverse Repo
Used for U.S.
government
disbursements

• An Overnight Reverse Repo (ON-RR) is a
short-term agreement to purchase
securities in order to sell them back at a
slightly higher price.
• Repos and reverse repos are used for
short-term borrowing and lending, often
overnight.
• Central banks use reverse repos to add
money to the money supply via open
market operations.
Temporary OMO (Open Market Operation)
https://www.investopedia.com/terms/r/reverserepurchaseagreement.asp

• The intention of the ON-RRP facility was to
expand the reach of Fed liabilities, permitting
better control of overnight interest rates.
• Frost et al. (2015):
an ON-RRP facility, paying a high interest
rate on overnight balances at the Fed
increases the probability of flight to safety.
• Greenwood et al. (2016):
argued that a large central bank balance
sheet, coupled with an active ON-RRP facility,
could promote efficiency.
• Flight to Safety or Promote Efficiency with
Retail CBDC?
Overnight Reverse Repo Purchase (ON-RRP)
The Introduction of CBDC has implications!

02 All About CBDC
Retail CBDC
• Electronic
• Widely Available
• Accessible Within and Outside
the Jurisdiction: A New Global
Asset Class?
• Central Bank Issued
• Liability or Digital Payment System?
• Authorised, Synthetic or Quasi CBDC?
• Full reserved or backed by a single
or a basket of CBDCs?
• Bearer Instrument

Deeper Look into Retail CBDC:
Unbundling: A store of value, a medium of exchange, and a unit of account
• A store of Value
Increased demand from local and foreign investors – monetary policy (MP) may become more
pronounced especially if available 24/7, more inclusive and interest bearing
• A medium of Exchange
Once money becomes digital, it cannot be independent of the design of the payment and settlement
systems, as well as individual or overall quantity restrictions
• A unit of Account
Complementary or Substitute. Complementary (non-interest bearing and 1 to 1), Substitute (interest
rate differential, lower risk, more convenient, bypass third party control?)
02 All About CBDC

02 All About CBDC
USA Singapore China Hong Kong
M0 The sum of currency in circulation
and reserve balances (deposits held
by banks and other depository
institutions in their accounts at the
Federal Reserve)
Currency in
circulation
Currency in
Circulation
**M0 is
referred to
currency in
circulation only
1. Certificates of Indebtedness,
which provide full backing to the banknotes
issued by note-issuing banks.
2. Government-issued notes and coins in
circulation
3. Aggregate Balance,
which is the sum of clearing account balances
kept with the HKMA
4. Exchange Fund Bills and Notes
Issued by the HKMA on behalf of the
Government for the account of the Exchange
Fund

02 All About CBDC
• CIAC = Coin + Notes = Cash
• M0 = Narrow Money = CIAC
• M1 = Narrow Money = CIAC +
Demand Deposits
• M2 = CIAC + Demand Deposit
+ Savings & Other Deposits +
Fixed Deposits
Before CBDC After CBDC
• CIAC* = Coins + Notes + Retail
CBDC?
• M0 = Narrow Money = CIAC*?
• M1 = Narrow Money = CIAC* +
Demand Deposits?
• M2 = Broad Money = CIAC* +
Demand Deposit + Savings &
Other Deposits + Fixed Deposits?
Or CBDC is neither M0 or M1 but M0.5? An entire new classification!

Two Elements of rCBDC
02 All About CBDC
• Digital Currency:
• the asset and payment instrument per
se.
• pertains to the economic design,
concerning aspects such as access,
remuneration, quantitative limits, and
convertibility.
• Electronic Payments:
• the underlying infrastructure that
allows CBDC to be transferred and
used for payments.
• concerns how a CBDC is provisioned,
its functional design, the technology
to be used, and the operational
processes and rules to be
implemented.
• concerns with Public Private
Partnership to provide a CBDC
infrastructure.
HKMA (2021), e_HKD: A Technical Perspective

02 All About CBDC
What is CBDC? More Questions
• Different rCBDC have different
implications and effects on MP
• What are the economic
consequences in adopting one-tier
and two-tier rCBDC system
respectively?
• Digital Instrument: a means of
payment and a financial asset
(attractive?)
• Liability of the central bank (or a
derivative of the liability issued by
the central bank?)
• Scalable and no storage cost (DLT?)
• Provides liquidity to the money
market?
• Bond-like or cash-like with expiry
date?
• Renumeration can be negative, zero
and/or positive?
• Cash-like with restrictions and
constraints?
• Programmable Super Asset: no
duration risk, no corporate risk, no
inflation risk?
• Programmable Privacy: Privacy
Protection, Full Anonymity, or
Managed Anonymity?
• Medium of Exchange: International
Trade, eCommerce?
• Borrowing in local CBDC?
• A dynamic programmable monetary
policy tool?

Even More Interesting Questions
02 All About CBDC
• Payment with restrictions
and conditions?
• An instrument for (Cross
Border) DeFi payments
and swaps?
• A prelude to a Regional
Currency or Bancor:
• The bancor was a
supranational currency
suggested by John
Maynard Keynes and E. F.
Schumacher
• A supranational currency
used in international trade
as a unit of account within
a multilateral clearing
system - an International
Clearing Union or simply a
Regional Sushi Swap?

02 All About CBDC
• Unlike larger countries, small and open economies
are not necessarily in control of its own interest rate,
the flow of capital and trade, and therefore trust
level.
• Unlike most other countries, Singapore has adopted
the use of the exchange rate rather than the interest
rate as the instrument of monetary policy.
• The choice of the exchange rate is predicated on the
Singapore economy's small size and its high degree
of openness to trade and capital flows.
• Developing Economies and Asian countries are
suspectable to rapid flow of capital and vulnerable to
currency and debt crises, unreliable communication
and power supply, as well as exclusion from the
formal economic and financial system.
• The considerations for CBDC design may not
necessarily fully aligned with developed markets.
• Monetary policy may not necessarily be as effective
as in developed market.
Notable Exceptions to Current Discussions

03 Hong Kong
Model
HK Model – Fully Backed by a Foreign Currency Plus
More than Adequate Reserves
• The Monetary Authority, who is the Chief Executive of the Hong Kong
Monetary Authority, is responsible for achieving the monetary policy
objectives, including determining the strategy, instruments and
operational means for doing so.
• The Monetary Authority is also responsible for maintaining the
stability and integrity of the monetary system of Hong Kong
• Main objective is to maintain a stable external exchange value of the
currency of Hong Kong, in terms of its exchange rate in the foreign
exchange market against the US dollar, at around HK$7.8 to
US$1,,through a Currency Board system.

03 Hong Kong
Model
Important Technical Features as a
Monetary Policy Tool
• Digital Payments infrastructure
• Renumeration
• Fixed Supply or Variable Quantity
• Expiry Date, Automatic Conversion or
Suspension
• Constraints or Restrictions of what kind of
liabilities can be exchanged
• Flexible eWallet Design for introduction of
constraints and restrictions, privacy versus
control
• DLT, Smart Contracts, General State (e.g.
UTXO) or/and Local State Based (e.g
Ethereum), DeFi-ready.
Auer and Boehme (2020), The Technology of Retail Central Bank Digital Currency, BIS.

03 Hong Kong
Model
More Specific Policy Questions
• Should central bank have the
monopoly of issuing rCBDC?
• HK model?
• E-CNY model?
• Should rCBDC be restricted in its
ability to swap for other assets,
primarily the debt of central
government or corporate debts
and loans?
• Should rCBDC has a role in
intervention in financial crises
(Universal Basic Income or
Targeted Grants)?

03 Hong Kong
Model Challenges
• Decline in LR demand of the use of
currency for payments: The use of
physical currency has been declining
but the stock is increasing.
• The possibility that there is a short-run
substitution: private traditional means
of payment versus central bank means
of payment
• The possibility that there is a long-run
substitution:
• domestic fiat versus stable coins (Foreign
rCBDC, Fiat-based tokens, and other
algorithmic-based tokens etc)

Singapore – Managed Float and Huge Reserves
04 What About Singapore?
• 40% of consumption is spent on imports.
• Trade can be as high as 300% of GDP.
• Price stability is maintained primary with
exchange rate policy.
• Small changes in interest rate differentials
can lead to large and rapid movement of
capital with its large offshore banking
sector dealing mainly with G3 (USD, EUR
and JPY) currencies.

Transmission of Exchange Rate
• Exchange rate as a dampeners for imported
inflation.
• Exchange as a moderator for the external
demand for Singapore goods and services,
and factor incomes.

Singapore Dollar Nominal Effective Exchange Rate
• Exchange is the target, and domestic interest rate
and money supply are a consequence
• SGD Interest Rates = f(foreign interest rates,
investor expectations of SGD, …)
• SGD is managed against a basket of currencies of
our major trading partners (also known as the
Singapore dollar nominal effective exchange rate
or S$NEER).
• MAS will intervene in the foreign exchange market
using spot or forward transactions through primary
dealers (PDs) within the policy band.
• MAS announces weekly average S$NEER data on
the first Monday of each month

How does rCBDC fit in into Wholesale CBDC?
• MAS decides on the level of Singapore dollar liquidity that is
sufficient to meet the banks’ demand for reserve and settlement
balances.
• The instruments for the money market operations are:
• direct borrowing;
• foreign exchange swaps;
• repurchase agreements (repos) of Singapore Government Securities
(SGS); and
• MAS Bills.
• Collateral DeFi arrangements between Wrapped CBDC and rCBDC with
private sector participants?

Structural Factors for Singapore Exchange Rate–based Monetary Policy
• High saving rates in the public sector
• Credibility of effective and pre-emptive policy decisions
• Sound and consistent policy, deep and efficient financial
market, robust corporate and prudent fiscal policy.
• Will rCBDC increase velocity or attract capital inflows?
• Will rCBDC accelerates withdrawal during a flight to
safety?
• How to throw sand to the gear?
• What features and designs can best mitigate the risks?

What are the Risks?
• Primary concerns associated with retail CBDC:
• disintermediation of financial intermediaries
• exacerbation of bank runs capital outflow
especially in times of financial crises
• maintenance of high security standards, privacy
protection and public trust in the CBDC system
• Digital illiteracy and exclusion, launching
strategy, public change in spending behaviour,
• KYC, data privacy, cross-border laundering and
accountability
• As is now known, these concerns can be
mitigated through the design of the CBDC itself
and other measures!
Bank of Thailand (2021), The Way Forward for Retail Central Bank Digital Currency in Thailand
Bank of Thailand (2021), The Way Forward for Retail Central Bank Digital Currency in Thailand

The Payment and Settlement Landscape
• Will the central bank be the super settlement agent and
crowd out clearing houses?
• How does a central bank balance innovation and
crowding out with rCBDC?
• How can rCBDC promote corporate inclusion?
• Digital Currency/Electronic Payment system of Cambodia?
• How does a central bank balance data privacy and
control via rCBDC?
• Two tier model of China?
• Multi function eWallet?
• Multi-tier of managed anonymity eWallet?
• Cryptography Technique (Project Ubin Phase 2)

Flight To Safety
• It depends on the nature of the central bank liabilities that market
participants might flee to.
• If rCBDC were to be programmed as a limited vehicle for flight, it must not
be useful in large transactions as in wholesale transactions.
• If rCBDC can be restricted to small transactions, it can only be hoarded as a
store of value and a safe asset.
• Kumhof and Noone (2019)
• If issued by central banks, should have features that make it inconvenient for its users.
• Private bank deposits and central bank reserves, should not be freely convertible into
CBDC.
• Throw sand in the gears of the financial system in all states of the world.
• Flight to safety may not then be a problem if the design is appropriate.

Earlier Discussions – Non DeFi
Source: BIS(2018), Central Bank Digital Currency

Renumeration: Interest Bearing
• Paying interest on CBDC potentially matters for the effects of
conventional monetary policy on the incidence of banking panics
and on economic welfare.
• Williamson (2021), Central bank digital currency and flight to
safety, (Working Paper)
• The fact that CBDC is potentially more widely-used in transactions cuts
two ways, if we take seriously the concerns voiced about flight to safety.
• That is, we might view CBDC as contributing to the efficiency of the
payments system, but perhaps not if this leads to greater financial
instability.
• Can renumeration be asymmetric and dynamic over time?

Prevention Options
• rCBDC interest rate relative to bank deposits:
Interest rate differential
• The ratio of CBDC/bank deposits
• Deposit insurance
• CBDC would indeed encourage banking panics.
• But the reason for this is that CBDC is potentially
more useful in transactions than is physical
currency and can potentially integrate with a
Digital ID solution.
• This not only mitigates the damage done by a
banking panic, but could imply that, in an ex ante
sense, economic welfare is higher in an economy
that experiences banking panics than in an
economy that does not.

rCBDC - More Benefits Than Costs?
• So, the model is consistent with the view
that CBDC issue would be a good thing,
even if it were to increase the likelihood
of banking panics.
• It can be argued that it improves in
important ways on traditional models of
financial crises and panics.
• While bank failures and panics are driven
by beliefs, it is essentially the potential
for bank insolvency that leads to a
banking panic.
• Deposit insurance can mitigate, but not
necessarily eliminate, banking panics.

Some Views
• Programmable Emergency OMO and Ultimate Liquidity Provider
• Orderly Portfolio Rebalancing of Loans
• Design to Benefit Funding Markets
• Design for Corporate Inclusion
• Design for Lower Cost of Transactions
Francesca Carapella (2021), Discussion of Central Bank Digital Currency and Flight to Safety
National Bank of Cambodia (2020), Project Baking: Next Generation Payment System

Design for Lower Cost of Transactions
• Constant money growth rule: Friedman, who died in 2006, proposed a
fixed monetary rule, which states that the Fed should be required to target
the growth rate of money to equal the growth rate of real GDP, leaving
the price level unchanged.
• This means that the nominal interest rate is zero.
• To achieve this, you need to have zero transaction cost and full
transparency.
• DeFi may be able to move the economy closer to Friedman’s rule with
lower counter party risk, thus lowering transaction costs with transparency.
• It will be attained by a rate of price deflation that makes the nominal rate
of interest equal to zero.
• If the physical economy is not growing, then perhaps the virtual economy
or the metaverse will grow and that a full reserve system may transpire
with a nominal zero interest, as it is now, in the physical world.

From Non-DLT to Smart Contract
• Prior to 2018, discussions on rCBDC were mainly against
the use of DLT technology and cryptocurrency models,
especially in the non-Asian literature.
• However, the DCEP demonstrated the advantages of
UTXO, offline P2P hard wallet transactions, managed
anonymity, allowance for Payment Services Providers
participation, multi-layer and functional wallets, and
privacy protection technology.
• Sentiments are also changing towards more
human/sustainability/solidarity-centric rather than
institution-centric.
• Various Asian designs, led by China DCEP, is similar in the
core design features and thinking.
• Mark Carney (2021), The Art of Central Banking in a
Centrifugal World.

BoT Summarised the Sentiment
• We hypothesize that a two-tier distribution model is preferable for a Thai
Baht retail CBDC, as it preserves the role of financial intermediaries and
payment service providers, while utilizing their existing resources.
• To mitigate bank runs during times of crises, the CBDC could be initially
designed as non-interest bearing akin to cash, with specified limits for
holding, transacting and conversion.
• We should aim to harness the strengths of both centralized and
decentralized technologies. While centralized technology offers
advantages in terms of scalability and performance, decentralized
technology offers greater resiliency, and its cryptographic techniques can
help enhance security.
• End-users should bear zero-to-minimal transaction costs when
transacting with CBDC, and the CBDC system should be open to private
sector programmability to drive financial innovation.

Some Interesting Views from Other
Regulators and Exchanges
• Money Definition Agnostic
• Technology Agnostic
• New Monetary Tools from rCBDC
• More Efficient Way to Management Money Flow Through
eWallets
• Facilitating Realtime Monitoring
• Notable Comments: NBC’s HE Dr Serey Chea, Ken Chiu of HKEX

Programmable Policy Instruments with DeFi
• Revisiting rCBDC Definition: Liability of central bank or Full
Reserve
• Open Market Operation: Liquidity Provider, Set/Pair retail trading
protocol, Smart Contracts, Programmable Collaterised Debt
Position
• Exchange Rates: Automatic Market Maker
• Others:
• Stability Fees – interest rate/renumeration
• No lockup Period - Free Entry and Exit
• Restrictions of Use
• Expiry Date

Some Considerations for Forex Transactions
• Inevitable that with Smart Contracts, the DeFi market is a low
hanging fruit
• But what regulation and licensing conditions are needed beyond
Omnibus Act?
• Users: Automatic Market Maker, Liquidity Provider, Vault Holder
• Maintainers: Developers, Oracles and Keepers
• Governors: Liquidity Provider of the last resort (Private? Central Bank?)
• What are the roles of private individuals and the Virtual Assets
Service Providers?
• Other thoughts
• Constant Product Market Making
• Constant Function Market Making
• Financial Inclusion, Reducing Rent-Seeking and Market Failures

Constant Function Market Maker

Design for the Future - Virtual Asset Service Providers
• While designing the rCBDC for the ecommerce or the virtual
economy, we must not forget that the metaverse is a twin
economy of the physical one as demonstrated with what NVIDIA
and BMW are doing.
• Whatever it is, the design for rCBDC must not only be discussed
with the old economy and old trusted third party in mind, but to
anticipate the exponential growth in the metaverse and Web3 in
mind.
05 Beyond Monetary Policy

Design to Accommodate Trade and Internet Economy
International Trade
• What’s the implication of retail CBDCs
on international trade policies?
• Will rCBDCs enable government
policies or allow people to circumvent
them?
• Can rCBDCs be designed to automate
the payment of tariffs and taxes?
The Internet Economy
• Payment Currency vs Settlement
Currency
• Payment for digital assets/tokens
• How will merchants/platforms handle
the accounting to meet each country’s
requirements?
• What is the role of rCBDC in Web3?

Possible Use Cases for rCBDC
Example: Foreign Debt Crisis
Country A has been facing mounting Foreign
Debt Crisis for many years and the pandemic
has brought the situation to a critical stage.
Challenges faced by the country:
- Balance of Payments Crisis: Insufficient
foreign reserves to fund trade deficit
- Inflation has pushed prices higher for
consumer goods and construction
materials
• Difficulties in attracting Foreign
Investments
• Lack of digital payments infrastructure
to enable increase in exports?
• Rigid PPP policies & infrastructure
deterring investment?
• Can rCBDC help to ease the
country’s financial woes?
• Reduce dependency on Forex?
• Enablement of fluid & open digital
payment infrastructure to ease liquidity
crunch?
• Ability to capture tax spillage from
booming internet revenue?

An Open Invitation!
• With a pallet that includes a new form of
public money linked to a plethora of new
dispersed private networks, central banks can
paint a new finance that will make payments
significantly cheaper and faster, open up new
forms of ownership and asset classes, power
contingent payments and distributed finance,
and integrate decentralised networks that
track and help reduce carbon emissions.
• By being resilient, dynamic, inclusive and
sustainable, the new art of money can serve
everyone across this new world.

References
• Lee, Yan and Wang (2021), A global perspective on central bank digital currency,
https://www.tandfonline.com/doi/full/10.1080/17538963.2020.1870279
• Lee and Teo (2021), The New Money: The Utility of Cryptocurrencies and the Need for a
New Monetary Policy, https://link.springer.com/chapter/10.1007/978-3-030-65781-9_7
• Lee (2021), Money and Central Banking, Tsinghua Financial Review,
http://www.thfr.com.cn/m.php?p=89586
• AP. (2021, July 14). Sri Lanka economy in crisis as debt mounts, reserves dwindle. The Hindu.
Retrieved October 17, 2021, from https://www.thehindu.com/news/international/sri-lanka-
economy-in-crisis-as-debt-mounts-reserves-dwindle/article35315515.ece.
• Hadad- Zervos, F. (n.d.). Foreign investment can help Sri Lanka build back. World Bank.
Retrieved October 17, 2021, from
https://www.worldbank.org/en/news/feature/2021/06/10/foreign-investment-can-help-sri-
lanka-build-back-better.
• Appreciation to individuals from various central banks and Research Assistants.

The Implications of Retail CBDCs for Monetary Policy

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The Implications of Retail CBDCs for Monetary Policy