Fed report examines CBDC compensation and convenience

The Federal Reserve Board of the United States, in a report that was made public on November 17th, stressed the significance of compensation in relation to the development of a digital currency issued by the central bank (CBDC). The theoretical literature on CBDCs in large, industrialized nations, with a primary focus on the United States, is investigated in this essay that is part of the Finance and Economics Discussion Series published by the Federal Reserve. It investigates the potential benefits and drawbacks of instituting a CBDC for the banking system, with a special emphasis on the crucial function that CBDC design plays in the execution of monetary policy and compensation (interest payments).

The authors come to the conclusion that a CBDC may help in the management of the Fed’s balance sheet by making the holding of CBDCs more or less attractive in comparison to bonds, and that the establishment of such a CBDC may also help in the control of bank disintermediation. According to the authors, “remuneration is without a doubt the key design aspect that any central bank would desire to study.” The following is what they then state:

Because CBDCs do not accrue interest, their only purpose is to act as a medium of exchange, and their value is almost completely predicated on their acceptability as a means of payment. In contrast, the rate of compensation for a CBDC might be used as a tool for policy in addition to making the CBDC more appealing as a vehicle for wealth accumulation. This would be in addition to the goal of making the CBDC more desirable.

Either proportional interest that is reported as a percentage or tiered interest that increases or decreases in a nonlinear reaction to the value of a holding may be used as a policy instrument. Tiered interest is more common.