Khóa luận tốt nghiệp: Central bank digital currency and the spillover of monetary policies

LIST OF ABBREVIATIONTerms Explain CBDC Central bank digital currencies SSR Shadow short rate TCI Total connectedness index CBDC_UI Central Bank Digital Currency Uncertainty IndexGFEVD Fo

VIETNAM NATIONAL UNIVERSITY

UNIVERSITY OF ECONOMICS AND BUSINESS

FACULTY: FINANCE — BANKING

TOPIC: CENTRAL BANK DIGITAL CURRENCY

AND THE SPILLOVER OF MONETARY POLICIES

Supervisor Lecturer: MSc Luong Tram AnhStudent: Nguyen Thi Hoai

Student ID: 20050443

Ha Noi, 2023

I hereby declare that this thesis is my own work Survey data, calculations and result

in the thesis are truthful and have never been published by anyone in any other work andeffort as well that it has not been submitted anywhere Where other sources of informationhave been used, they have been acknowledged The reference to source material has beenmade citing and referencing in accordance with the faculty’s regulations

Hanoi, 2023Confirmation of instructor Confirmation of student

MSc Luong Tram Anh Nguyen Thi Hoai

A completed study would not be done without any assistance Therefore, the authorwho conducted this research gratefully gives acknowledgement to their support andmotivation during the time of doing this research as a requirement of completing my thesis

The author would like to thank the Board of the University of Economics andBusiness — Vietnam National University for creating favorable conditions for the author tocomplete this thesis

The author also would like to thank the lecturers of the Faculty of Finance andBanking, University of Economics and Business — Vietnam National University for theirhelp the author in the thesis implementation process

In particular, I would like to express my endless thanks and gratefulness to mysupervisor MSc Luong Tram Anh Her kindly support and continuous advice went throughthe process of completion of my thesis Her encouragement and comments had significantlyenriched and improved my work Without her motivation and instructions, the thesis wouldhave been impossible to be done effectively

Thank you very much!

Ha Noi, 2023

TABLE OF CONTENTS

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LIST OF ABBREVIATION

Terms Explain

CBDC Central bank digital currencies

SSR Shadow short rate

TCI Total connectedness index

CBDC_UI Central Bank Digital Currency Uncertainty IndexGFEVD Forecast error variance decomposition

TVP-VAR Time-varying parameter vector autoregressions

GPR Geopolitical risk index

EPU The Economic policy uncertainty

OLS Ordinary least squares

VIF Variance Inflation Factor

LIST OE TABLES

Table 2.1: Definition of CBDCC - -.- =5 - S1 1S 1n 1 9 1 56 17Table 4.1 Descriptive statistic of Shadow short raf(©S - -.- «<2 s+ 34Table 4 2 Average connecfedness MEASULE .-‹ - -« « ««« « «<< < s<s+ 36Table 4.2: Descriptive sfafÏS(ÏCS - - c c c9 Ơn 9n SH SỰ HH SH Họ 1 9Ý 1 0V 00808 41

Table 4.3: Correlation) matrix 0.csccsccsccsnsssscnscsecsccsocssentssccsssesecsesseuessees 42Table 4.4 Variance Inflation Factor - << << c1 1 11 15 55 43

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LIST OF FIGURES

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CHAPTER 1: INTRODUCTION1.1 The urgency of the topic

Technological innovation is rapidly shifting people’s lifestyles The rapiddigitization of the world has made it clear that traditional money needs to be replaced withalternatives The advent of cryptocurrency has raised concerns among central banksworldwide If such cryptocurrencies gain additional market shares, monetary policytransmission and monetary sovereignty could be impaired (ECB, 2020)

In response to such concerns, central banks around the world are increasinglylooking into the possibility of issuing their own digital currencies — the central bank digitalcurrencies (CBDC) (Cheng, 2022; He, 2018) This type of currency is a digital form oftraditional fiat currency that is issued by a central bank CBDC is commonly designed toco-exist with physical forms of currency and is expected to provide additional benefits such

as improved security, greater efficiency, and lower transaction costs (PBOC, 2021; Xu etal., 2022) By December 2022, 130 countries have conducted their explanatory CBDCresearch;21 countries have developed and tested their CBDC in a real environment and 11have already launched their CBDCs (Atlantic Council, 2023) A CBDC is considered aFinancial innovation to impact and improve the effectiveness of monetary policy(Mohammad et al., 2020) CBDC appears as a tool to help countries monitor economicactivities as well as limit bribing at local officials levels, becoming a transmitting monetarypolicy channel (McKinsey, 2023) CBDCs can improve monetary policy transmission andeffectiveness by allowing the central bank to implement negative interest rates or helicoptermoney more easily and directly

As an emerging form of currency, the issuance and circulation mode of CBDC isessentially different from that of traditional paper currency and electronic currency.Compared with traditional currency, it has features and advantages such as stability,convenience, low cost, universality, programmability, liquidity, and security, and isbecoming a trend of currency development While it brings convenience to people, it alsohas an obvious impact on the economy, among which the impact on monetary policy is the

introducing a range of monetary policies As a result, many central banks have turned tounconventional monetary policy tools, such as quantitative easing and forward guidance,

to provide additional support to their economies One of the challenges faced bypolicymakers in this environment is assessing the effectiveness of their monetary policies.One way to evaluate the effectiveness of monetary policies is to examine the impact ofCBDC on the co-movement among monetary policies

The spillover of CBDC on the co-movement among monetary policy is an importantresearch question because it can help us understand the degree to which monetary policieshave been impacted on the coordinated across major economies If there is a high degree

of CBDC impact on the co-movement among short shadow rates, it could suggest thatCBDC volatility have highly Implications for monetary policy If there is low degree

Although the impact of digital currency on monetary policy has been widelyconcerned by the central banks, academia, and industry since its emergence (Fung et al.,2016; Broadbent B, 2016; Bjerg O et al., 2018; Armelius H et al., 2020;Huber J., 2019) ,the relevant studies are not specific enough There are several gaps in the existing literaturethat this study aims to address First, most studies have focused on research and discussionsrevolve around a fundamental qualitative analysis of the CBDC, its technologicalinnovations, and its regulatory framework These studies don't give any attention to thequestion of how regulators and volatility about the CBDC may affect the monetary policiesparticularly through interest rate channels Moreover, many studies cannot objectivelyreflect the actual situation of CBDC issuance and circulation Second, most studies havefocused on developed economies of countries with CBDC, rather than examining the co-movement among short shadow rates in a broader range of countries Finally, most studieshave examined the impact of CBDC on the co-movement among short shadow rates inparticularly country (Jiemeng Yang etal., 2022; Dyah Tiara et al., 2022), rather thanexamining whether this level has more scope of countries in the world

Therefore, as the circulation of CBDC is about to expand, in-depth research of theimpact of CBDC on monetary policy has important theoretical and practical significance

innovate monetary policy tools, dredge the transmission channel of monetary policy, andthen improve the effectiveness of monetary policy.

This study aims to fill these gaps in the literature by examining analyze the impact

of CBDC on the central bank’s monetary policy from transmission mechanism interest rate,beside this thesis will examine the co-movement among short shadow rates Specifically, Iwill examine the extent to which monetary policies have moved together across differentregions, and whether this co-movement has persisted over time Our analysis willcontribute to a better understanding of the effectiveness of monetary policies and provideinsights into the degree impact of CBDC on the coordination among central banksResearch on the subject matter is both timely and necessary to aid global economic andfinancial challenges facing policymakers and all stakeholders of eco- nomic and financialstability This study in order to get some meaningful and enlightening conclusions, andprovide a reference for the central bank to issue digital currency in the future

1.2 Objectives of the study

The research objective of this graduation thesis is to examine the impact of CBDCs

on the co-movement among short shadow rates of countries in research scopes

Specifically, the thesis aims to investigate whether the short shadow rates ofdifferent countries moved together, and if so, to what extent This analysis could provideinsights inform policymakers on how to respond to similar events in the future

To achieve this objective, the thesis may use econometric techniques to analyzetimeseries data on CBDC uncertainty index and short shadow rates from various countries.The study may also consider factors such as changes in monetary policy andmacroeconomic conditions that could have influenced the impact of CBDC on the co-movement of short shadow rates

Overall, the research objective of this graduation thesis is to contribute to ourunderstanding of short shadow rates behaved and how CBDCs spillover on that

1.3 Tasks of the study

Organize the theoretical underpinnings of Central bank digital currency and the

Collecting information, data, assess, examine, and test the Volatility Spilloversbetween Central bank digital currency uncertainty and the monetary policies

Give advice to Government agencies on recommendations to the governmentagency for monitoring the fluctuations of CBDC and their impact on policies Summarizingall obtained results and outlines directions for future research and practical implications inthis field

1.4 Research scopes

The analysis uses documents of General central bank digital currency uncertaintyindex, monetary policies data between January 2015 - June 2023

e Scope of content: the impact of CBDC on the connectedness among short shadow

rates for selected economies or regions

e Scope of space: CBDC global uncertainty; the connectedness of monetary policies

among United States of America, Japan, United Kingdom, Switzerland, Canada,Australia and New Zealand

e Scope of time: during the period from January Ind, 2015 to 30th June, 20231.5 Research questions

This thesis plans to answer the following three research questions:

e To what extent do short shadow rates co-move with each other during the research

period?

e How have the CBDC Uncertainty impacted on the connectedness among short

shadow rates ?

e What implications do the findings have for policymakers and investors?

CHAPTER 2: LITERATURE REVIEW2.1 Monetary policies

2.1.1 Definition

According to Cecchetti & Schoenholtz (2018) “Monetary policy is the process by

inflation rate or monetary policy to ensure price stability and general trust in the currency.”Mishkin & Eakins (2016) define monetary policy as “Monetary policy is the management

of money and interest rates by central banks to achieve macroeconomic objectives such asprice stability, high employment, and sustainable economic growth” As following,monetary policy represents: a set of actions and decisions undertaken by a country’s centralbank to regulate and control the money supply, interest rates, exchange rates, and othermonetary tools to influence financial and economic activities within its jurisdiction Thedescription of the concept of monetary policy is stated on the Federal Reserve Bank of SanFrancisco’s website: “Monetary policy refers to the actions taken by a central bank toinfluence the availability and cost of money and credit to help promote national economicgoals It is aimed at promoting maximum employment, stable prices, and moderate long-term interest rates.” The ultimate goal of monetary policy is to achieve macroeconomicobjectives, such as price stability, economic growth, inflation control, and financialstability

Monetary policy is a powerful tool used by governments and central banks tomanage the economy by influencing the supply and demand of money, credit, and interestrates According to the book "Monetary Policy and Central Banking" by Carl E Walsh,monetary policy refers to "the actions taken by the central bank or other regulatoryauthorities to manage the availability, cost, and use of money and credit to achieve specificmacroeconomic goals." These goals typically include controlling inflation, promotingeconomic growth, and maintaining financial stability

In the book "Principles of Economics" by Gregory Mankiw, monetary policy isdefined as "the setting of the money supply and the interest rate by policymakers in thecentral bank." The book goes on to explain that the central bank can adjust the moneysupply by buying or selling government securities, and can adjust interest rates by changingthe discount rate or the reserve requirement

In summary, monetary policy refers to the actions taken by central banks andgovernments to manage the supply and demand of money, credit, and interest rates in the

economy This policy is aimed at achieving macroeconomic goals such as controllinginflation, promoting economic growth, and maintaining financial stability.

Central banks typically use a variety of tools to implement monetary policy, whichmay include open market operations (buying or selling government securities), discountrate (the rate at which commercial banks can borrow from the central bank), reserverequirements (the amount of reserves commercial banks are required to hold), andcommunication or forward guidance (indicating the central bank's future policy intentions).These tools are used to influence the supply of money and credit in the economy, which inturn affects interest rates, investment, consumption, and overall economic activity One ofthe most commonly used tools by central banks is the discount rate, which is the interestrate at which commercial banks can borrow from the central bank As Bernanke, et al.(2001) state, when the central bank lowers the discount rate, it becomes cheaper forcommercial banks to borrow money, which can encourage them to lend more to householdsand businesses This, in turn, can increase the money supply in the economy Conversely,when the central bank raises the discount rate, it becomes more expensive for commercialbanks to borrow money, which can discourage them from lending and decrease the moneysupply

Reserve requirements are another tool used by central banks to influence the moneysupply, stated by Iqbal (2020) Reserve requirements refer to the amount of reserves thatcommercial banks are required to hold by law When the central bank lowers reserverequirements, commercial banks are able to lend more money and increase the moneysupply in the economy Conversely, when the central bank raises reserve requirements,commercial banks are required to hold more reserves, which can decrease the amount ofmoney they have available to lend and decrease the money supply

Finally, communication or forward guidance is a tool used by central banks to signaltheir future policy intentions to the public and financial markets By providing guidance ontheir future policy actions, central banks can influence expectations and shape marketreactions For example, if a central bank indicates that it plans to lower interest rates in the

which can stimulate economic growth and increase the money supply Mishkin & Eakins(2012) discusses about central banks and monetary policy in “Financial markets andinstitutions” which can be sum up as follow Monetary policy can be expansionary, aimed

at stimulating economic growth and reducing unemployment, or contractionary, aimed atcontrolling inflation and preventing economic overheating Expansionary monetary policyaims to stimulate economic growth and reduce unemployment by increasing the moneysupply and lowering interest rates This can be achieved through various mechanisms, such

as buying government securities (bonds) from the open market, which injects liquidity intothe banking system and increases the money supply Additionally, the central bank maylower the discount rate, which is the interest rate at which banks can borrow from the centralbank, making it cheaper for banks to access funds and encouraging lending to businessesand individuals

On the other hand, contractionary monetary policy aims to control inflation andprevent economic overheating by reducing the money supply and raising interest rates Thecentral bank may also raise the discount rate, making it more expensive for banks to borrowfrom the central bank and thereby reducing their ability to lend to businesses andindividuals The specific mechanisms and decisions regarding buying or sellinggovernment securities and adjusting the discount rate may vary depending on the centralbank's policy framework and the economic conditions of a particular country These actionsare part of the central bank's efforts to implement monetary policy and achieve itsmacroeconomic objectives of promoting economic growth, controlling inflation, andmaintaining price stability The specific strategies and actions undertaken by a central bank

as part of its monetary policy can vary depending on the economic conditions, goals, andpreferences of the country or region in question

2.1.2 Factors affecting monetary policies

Factors affecting monetary policies: Various economic, financial, and policy factorsthat influence the level and direction of interest rates, including inflation expectations,central bank policies, supply and demand dynamics in financial markets, economic

conditions, and global economic and geopolitical events, according to the Federal ReserveBank There are several factors that can affect interest rates, including:

i Inflation expectations: Expected inflation can influence monetary policy passthrough interest rates If investors expect higher inflation in the future, they may demandhigher interest rates to compensate for the erosion of purchasing power due to inflation

ii Economic uncertainty: The overall health of the economy, including factors such

as GDP growth, employment, and consumer spending, can impact interest rates Duringperiods of economic expansion, interest rates may be higher as demand for credit increases,while during economic downturns, interest rates may be lower as central banks seek tostimulate borrowing and spending

11 Supply and demand for credit: The supply and demand dynamics in creditmarkets can affect monetary policy When there is a higher demand for credit relative tosupply, interest rates of monetary policy tend to rise, and vice versa Factors such asgovernment borrowing, corporate borrowing, and individual borrowing can impact theoverall supply and demand for credit

v Risk perception: The perceived risk associated with lending or borrowing canimpact interest rates Lenders may demand higher interest rates for loans that are consideredmore risky, such as loans to borrowers with poor credit history or loans for investmentswith higher risk profiles

vi Global factors — geopolitical risk : International economic and geopolitical eventscan also impact interest rates Factors such as global economic conditions, exchange rates,and geopolitical tensions can affect interest rates in different countries and regions Globalfinancial market fluctuations, the financial situations of major countries such as the UnitedStates and China, and global economic factors such as oil and gold prices can also affectthe interest rates of a country

It's important to note that interest rates are complex and can be influenced by acombination of factors The interplay between these factors can vary over time and canresult in fluctuations in interest rates in different markets and regions

2.1.3 The international spillover among monetary policies countries

The monetary policies of different countries may vary depending on various factors,such as the level of economic growth, inflation rate, political and financial conditions, andthe demand for borrowing and lending by organizations and individuals Monetary policiesand economic conditions of each country also affect the interest rates of that country.Therefore, the monetary policies of different countries are often not the same and maychange over time

The issue of monetary policy spillovers can be traced as far back as to the 18thcentury in David Hume’s Essays, Moral, Political, and Literary (Coeur’e, 2016).Theoretical modelshave rigorously analyzed the international spillovers of monetarypolicy, and reviewedthe case for and against monetary policy coordination since themid-1980s (Taylor, 2013) Naturally, the interest in monetary policy spillovers hasalready be addressed bymultiple researchers One study that is similar to ours isconducted by Claus et al (2016), whereby the authors used a constant parameter latentfactor model Their results indicatethat there is significant evidence of spillovers acrossmonetary policies between the USand Japan, with the effect being stronger during

unconventional monetary policy regimes On another note, Liu et al (2018) examinewhether monetary policy decisions of majorcentral banks affect each other

Using the TVP-VAR-based model, Antonakakis et al (2019) observe that overallmonetary policy spillovers do not change dramatically between the unconventional periodand conventional era, as indicated by both total connectedness indexes (TCIs), the US isthe dominant transmitter of spillovers during the unconventional US monetary policy era,while a net receiver of spillovers in the conventional US monetary policy era In otherwords, the introduction of quantitative easing in the US can be associated with a 18significant increase in international monetary policy spillovers originating from the US

“These results have important policy implications in the sense that, during episodes ofsevere crises the design of monetary policy could reduce the impact other countries'monetary policy has on domestic monetary policy In other words, there could be possible

gains from coordinating monetary policy decisions, especially in the wake of extraordinarysituations like those observed during the recent global financial and the European debtcrises” (Antonakakis et al., 2019).

2.2 Central Bank Digital Currency

2.2.1 A fundamental background

The advent of Cryptocurrency and other private monies, has raised concerns amongcentral banks worldwide In the 20th century, money was based predominantly on creditrelationships: central bank money, or base money, represents a credit relationship betweenthe central bank and citizensnin - the case of cash and between the central bank andcommercial banks - in the case of reserves If crypto assets indeed lead to a more prominentrole for commodity money in the digital age, the demand for central bank money is likely

to decline (He, 2018) Otherwise, central banks conduct monetary policy by setting term interest rates in the interbank market for reserves (or clearing balances they keep withthe central bank) If central bank money no longer defines the unit of account for mosteconomic activities then the central bank’s monetary policy becomes irrelevant When alarge part of the domestic financial system operates with a foreign currency, monetarypolicy for the local currency becomes disconnected from the local economy For thesolution, He (2018) stated that central banks should continue to strive to make fiatcurrencies better and more stable unit of account In response to such concerns, centralbanks around the world are increasingly looking into the possibility of issuing their owndigital currencies CBDC (Cheng, 2022; He, 2018)

short-Central Bank Digital Currency is a digital form of cash issued by a nation's centralbank that has the full backing of the central bank The Bank of England have described aCBDC as electronic CB money that: (i) Can be accessed more broadly than reserves, (ii)Potentially has much greater functionality for retail transactions than cash, (iii) Has aseparate operational structure to other forms of Central Bank money, allowing it topotentially serve a different core purpose, and (iv) Can be interest bearing, under realisticassumptions paying a rate that would be different to the rate on reserves (Kumhof, M.,

provide a stable and regulated digital currency, and reduce dependence on foreigncurrencies.

CBDC has been attracting significant attention from banking authorities worldwide

In principle, CBDC can be viewed as a digital extension of sovereign currency issued by acentral bank or monetary authority (Kiff et al., 2020) In other words, the perception ofCBDC is simply money issued by the central bank in electronic format, which is universallyaccessible (Davoodalhosseini, 2021) Table 1 provides a list of definitions of CBDCprovided by some international institutions, professional bodies and central bankauthorities Because it is considered as a form of sovereign currency, CBDC should havefour fundamental functions of a currency, including: 1) Medium of exchange; ii) store ofvalue; iii) unit of account; and iv) standard of deferred payment (Hanawa, 1981; Lee et al.,2021)

Table 2.1: Definition of CBDC

Author Year | Definition of CBDC

Brookings International | 2020 | A fiat currency issued by central banks in digital

(Allen et al 2020) form.

European Central Bank | 2020 | A form of central bank money which is managed

(Bindseil 2020) through electronic means and is accessible to the

larger public

Bank of England (Kumhof | 2018 | An electronic central bank money which is more

and Noone, 2018); widely accessible than reserves, is interest

Meaning et al 2018) bearing, has functionality for retail transactions,

has a different operational structure as compared

to other forms of money

An electronic, fiat liability of a central bank thatcan be used to settle payments or as a store of

IMF (Kiff et al 2020)

value

Bank for International | 2020 | A digital form of central bank money that is

Settlements (Auer, Cornelli, different from balances in traditional reserves or

and Frost 2020) settlement accounts.

Copenhagen Business | 2017 | Universally accepted electronic money which is

School (Bjerg 2017) issued by the central

bank

Hoover Institution (Bordo | 2017 | Two mediums of exchange in the form of

and Levin 2017) “CBDC tokens” and “CBDC

accounts”

2020 | The digitized form of fiat money which is issued

and appears on the “Debit side” on the balancesheet of the Central Bank (or monetaryauthorities)

Source: Lee et al (2021)Overall, CBDC is the legal tender of a country issued by the central bank (with directclaim on central banks) and exists in a digital form As digital cash, CBDC can be used byorganizations and individuals to pay for goods and services (retail CBDC) or betweenbanks/financial institutions to pay for transactions on financial markets (wholesaleCBDCs) The retail CBDC would be used for payment, for remittances, and possibly toreceive government incentives and subsidies The retail CBDCs are designed to improvesocial welfare Wholesales CBDC is seen as less of a priority globally as compared to retailCBDC According to the survey, payment-related motivation emerges as most importantfor both advanced economies as well as emerging and developing economies The only

CBDC is in cross-border payments efficiency In the “Other” section, central banks voicetheir own consideration for wholesales retail as the tools to develop capital markets,enhance cyber resilience, and improve in securities trading and interbank settlement.

According to the Atlantic Council, a total of 87 countries are exploring issuing aCBDC as of March 2022, compared to just 35 countries in May 2020 CBDCs have become

a popular topic of discussion in the global financial system, with many countriesconsidering the development of their own digital currencies (BIS, 2021) The Bank forInternational Settlements (BIS) conducted a survey in 2020, which revealed that over 80%

of central banks around the world were engaged in some form of CBDC work, with about40% actively pursuing CBDC development (BIS, 2020) The main motivations for CBDCdevelopment were found to be improving payment system efficiency, increasing financialinclusion, and maintaining monetary policies (BIS, 2021) CBDCs have attractedincreasing attention from policymakers and researchers as they may have a fundamentalimpact on both domestic and international economic and financial stability (IMF 2023).Moreover, CBDCs may have implications for financial stability, monetary policytransmission, international spillovers, and digital sovereignty (Adrian 2019; BIS 2018; IMF2018)

Proponents of CBDC argue that CBDCs have the potential to enhance transactionefficiency, bolster transaction security, reduce the expenses associated with cross-borderpayments, advance financial inclusion, and maintain economic stability (Barontini &Holden, 2019) A recent study by Boar and Werhli (2021) reflects these expectations Theyconducted a survey among 65 central banks about their engagement in CBDC work, theirmotivations and intentions regarding CBDC issuance Of the respondents, 21 are fromadvance economies and the rest are from emerging market and developing economies Thereport reveals that, among other things, the main drivers for the adoption of CBDC inemerging and developing economies are financial inclusion, domestic payment efficiency,and management monetary policies The use of digital currency may assist the central bank

to more accurately account for the money supply, its structure, velocity, multiplier, time

CBDC also helps to counter the mass adoption of privately issued digital currencies, as it

is backed by trusted governments and is based on domestic accounts Another form ofdigital currencies, such as a private stable coin (e.g., Libra or now known as Diem), posesrisks to monetary policy and raises concerns about data privacy and abuse of personalinformation because it is difficult to regulate CBDC helps the central bank to capture thenecessary data, and it is easier to detect illegal activities such as tax evasion, terroristfinancing and money laundering CBDC will mitigate the risk of non-fiat eMoney or non-sovereign money, replacing the fiat that will weaken the fiscal policy sovereignty Also,interest-bearing CBDC can be used as a direct monetary policy tool and can give the centralbanks more direct control of the money supply In contrast, non-interest-bearing willperform the function of digital public infrastructure to overcome friction in the financialspace (Lee et al (2021)

2.2.2 The impact of CBDC on monetary policies

There are lots of extensive discussions and arguments between economists andacademics about the implementation of the Central Bank Digital Currency thesearguments leading central banks to research on new innovative payment design as well asthe way to issue currency, in particular CBDC An increasing number of central banks andinternational financial organizations have been actively exploring the possibilities ofCBDC, and released CBDC research reports with emphasis on technical analysis, as well

as the impact on monetary policy As of mid-July 2020, at least 36 central banks aroundthe world have announced retail or wholesale CBDC plans At present, Ecuador, Ukraineand Uruguay have completed the retail CBDC pilot, and six retail CBDC pilot projects are

in progress in China, the Bahamas, Cambodia, the Eastern Caribbean monetary union,South Korea and Sweden

CBDC appears as a tool to help countries monitor economic activities as well aslimit bribing at local officials levels (McKinsey, 2023) As specified by Mohammad (2020)they said that CBDCs can improve monetary policy transmission and effectiveness byallowing the central bank to implement negative interest rates or helicopter money more

easily and directly CBDC helps the central bank to capture the necessary data, and it iseasier to detect illegal activities such as tax evasion, terrorist financing and moneylaundering CBDC will mitigate the risk of non-fiat eMoney or non-sovereign money,replacing the fiat that will weaken the fiscal policy sovereignty Also, interest-bearingCBDC can be used as a direct monetary policy tool and can give the central banks moredirect control of the money supply In contrast, non-interest-bearing will perform thefunction of digital public infrastructure to overcome friction in the financial space (Lee,2021)

Monika Piazzesi et al., (2019) introduced that the central bank issues a central bankdigital currency (CBDC), for which it controls both the quantity and the monetary policies.They derive the dampening of monetary policy as well as conditions for determinacy ofequilibrium for CBDC model Finally this study said that the CBDC model serves as auseful reduced form guide for assessing policy transmission

Researching about CBDC design impact monetary policy pass-through, Rodney etal., 2022 find that with low interest on reserves (IOR) rates, large banks are non-responsive

to IOR rate changes, leading to weak pass-through of IOR rate changes to deposit rates Inthese circumstances, CBDC may be used to provide competitive pressure to drive updeposit rates and improve monetary policy transmission Increasing the CBDC interest ratepast a point where it becomes a binding floor, increases deposit rates but leads to greaterinequality of market shares in both deposit and lending markets and can reduce theresponsiveness of deposit rates to changes in the IOR rate

The available literature suggests that the introduction of CBDC might impactmonetary policy transmission mechanisms only if CBDC is interest-bearing (BIS 2018)

In the opposite case, the transmission mechanism is affected only if the interest rates areclose to zero (Sveriges Riksbank 2018)

The discussion in literature is centred around the impact of CBDCs introduction onthe effective lower bound, which would be very different, depending on the remuneration

of CBDC accounts If CBDC accounts were non-interest bearing, then, as long as the policy

monetary policy The situation would change once the central bank tried to cut interest ratesbelow zero, and commercial banks tried to pass it on to deponents Since the cost of holdingCBDC is close to zero, the deposit holders would most probably switch to CBDC accountswith the central bank The situation would hence be different from now when, due to costsassociated with holding cash, slightly negative interest rates are possible This means thatthe introduction of noninterest bearing CBDC leads to higher effective lower bound,thereby narrowing the room for manoeuvre for monetary policy This conclusion is anadaptation of a liquidity trap concept, as drafted by Keynes (1934) A rise of the effectivelower bound to zero has further important implications not only for interest rate settingitself, but also for monetary policy communication As Norges Bank (2018) points out, theability of central bank to influence expectations, for instance with forward guidance, would

be weaker than it is now If CBDC accounts were remunerated, the CBDC rate wouldconstitute the floor for the policy rates With cash still in place, the effective lower boundwould be largely unchanged It would still be the yield on cash, 1.e slightly below zero(Barrdear and Kumhof 2016) As the role of cash diminishes, the effective lower boundmight even fall, since it would be easier for the central bank to impact monetary policies inthe economy with CBDC setting, thereby increasing the monetary policy space (SverigesRiksbank 2018) Effective lower bound might be even eliminated along with cash, which,

by allowing unrestricted monetary policy space, could prompt central banks to lower theirinflation targets (Bordo and Levin 2017)

Some scholars think that the introduction of CBDC will bring new monetary policytools Sveriges Riksbank (2018) believes that with the weakening of the role of cash, thecentral bank is easier to affect the interest rate in the economy by setting CBDC interestrate, so as to expand the space of monetary policy Harrison and Thomas (2019) found thatthey can use the transfer of monetary financing as a policy tool within the effective lowerbound without giving up the ability to use short-term bond interest rates to stabilize theeconomy in normal times

Others scholars focus on the impact of issuing CBDC on monetary policies through

with CBDC should be accompanied by interest, and this framework will promote pricestability Besides, the effective lower bound may even be eliminated together with cash.Norges Bank (2018) believes that the impact of CBDC on bank lending rates and overalllending channels is not obvious Harrison and Thomas (2019) considered CBDC withinterest income and found that it can use money-financed transfers as a policy tool withinthe effective lower limit without giving up its ability to use short-term bond interest rates

to stabilize the economy in normal times However, Gurtler et al (2017) pointed out thatthe deposit outflow of commercial banks and the related needs to provide external fundsfrom different sources caused by CBDC do pose challenges to financial stability and have

a potential impact on the efficiency of the entire monetary transmission mechanism.Yanagawa and Yamaoka (2019) believe that the central bank should not only pay attention

to the impact of digital currency on the payment system, but also the impact of the entirefinancial system, especially the impact of network externalities

Beniak, P (2019) said that CBDC is a payment innovation solution, Rapiddigitalisation of payments that leads to greater cost and time efficiency, yet could alsopotentially trigger legal and security challenges as well as lead to weakening of financialstability and less effective monetary policy transmission Depending on the versionassumed by a particular central bank, central bank digital currency can have an impact onmonetary policy implementation and transmission mechanism

The issuance of CBDC will also shorten the time lag of interest rate channels andbetter meet the requirements of financial services to the real economy (Fang X et al., 2020).The application of big data analysis will enhance the ability of the central bank to guidemarket interest rates through monetary policy tools It can also help to acquire more andmore real-time information, thus making interest rate adjustment more sensitive and more

in line with current market conditions Through the management method based on theconditional trigger of loan interest rate (Xie X et al., 2019), the benchmark interest rate can

be effectively transmitted to the loan interest rate in real time, and the problems of monetarypolicy transmission lag caused by the loss of control over money can be solved The time-

contemporaneous problem of the current monetary policy operation, so that the time point

of currency takes effect is not limited to the current issue of currency, but extended to acertain point in the future in line with the policy objectives, avoiding money idling, andthus reducing the transmission lag of monetary policy

CHAPTER 3: RESEARCH METHODOLOGY3.1 Researsign design

The research process is divided into 3 main steps First, the author identifies theproblem to be analyzed through market research, specifically by reviewing the articles,

news, research article Then, based on the overview to choose choose the research

variable as well as the appropriate model The next step is to collect secondary data and

feed it into the model And the last step, the research synthesizes the results and makes

recommendations suitable

Study overview ¬

Research gap

Ask research question L_

Define research problem

Outline of research

framework —

Collecting data, apply

research methods

Synthesize and evaluate the model results

and then make recommendations suitable Step 3

Figure 3.1 Research design

Sources: Author