Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / How Central Banks Are Using CBDCs for Monetary Policy
Transcript
- Lucas: We talk a lot on this show about the tools central banks reach for — rate hikes, quantitative easing, forward guidance. But there's a new tool slowly coming into focus that could change how monetary policy actually reaches people's wallets. Luna: You're talking about central bank digital currencies — CBDCs. It feels like every other week, another country is piloting one. Lucas: Exactly. As of June 2026, over 130 countries are exploring CBDCs in some form. But the most advanced by far is China's digital yuan, or e cny. The People's Bank of China has been running pilot programs since 2020, and they've already distributed tens of billions of yuan in digital currency. Luna: And the really interesting angle is not just about payments. It's that a CBDC could become a direct channel for monetary policy. Lucas: Right. The core idea is this: if a central bank issues digital currency that households and businesses can hold directly — not through a commercial bank — then the central bank can potentially influence spending and saving more directly. We're talking about programmable money that could be set to expire, or carry an interest rate that varies, or even be restricted to certain types of purchases. Luna: Let's unpack that. So with the digital yuan, the PBOC has already experimented with features like 'controllable anonymity' and spending limits. But the real policy twist is the possibility of negative interest rates on CBDC holdings. Lucas: That's the big one. Right now, central banks can set negative policy rates, but banks are often reluctant to pass those on to depositors — they worry about customers pulling their cash out. With a CBDC, the central bank could apply a negative rate directly on digital currency balances. If your digital yuan loses value if you hold it too long, you're incentivized to spend it. Luna: Which is exactly what you want during deflationary periods. You want to discourage hoarding and encourage consumption. It's like the old idea of stamped money from the 1930s, but digitized. Lucas: Silvio Gesell's concept, exactly. But there are practical challenges. For one, if the CBDC pays a negative rate, people might just convert their digital currency into physical cash — which still pays zero. So to make it effective, you'd either need to limit cash convertibility or eventually phase out physical currency altogether. Luna: And that's a huge step. Most central banks are not ready to take cash away from people. But the digital yuan pilot has already shown that the PBOC can impose expiration dates on certain 'red packets' — essentially digital gifts that must be spent within a week. Lucas: And that's a form of programmability. A central bank could, in theory, program a stimulus payment that automatically expires after 90 days if not spent. That would guarantee a consumption boost, rather than households saving the stimulus check. During the pandemic, many governments sent out checks, and a lot of it went into savings. With a programmable CBDC, you could force the velocity. Luna: But that raises serious questions about privacy and control. The idea of the central bank knowing every transaction and being able to restrict how you spend money — that's a political non-starter in many democracies. Lucas: Absolutely. And that's why the design varies by country. The European Central Bank's digital euro project, for example, emphasizes privacy and plans to limit holdings to something like 3,000 euros per person to prevent bank disintermediation. They don't want people moving all their deposits out of commercial banks and into the central bank's digital wallet. Luna: Because if that happened, banks would lose their funding base and couldn't lend. That could crater the economy. Lucas: Exactly. So there's a balancing act. You want the CBDC to be attractive enough to be useful for policy transmission, but not so attractive that it destabilizes the banking system. That's why many proposals include tiered remuneration — the first few thousand dollars earn zero or positive interest, and anything above that earns a negative rate or a fee. Luna: So the central bank can fine-tune incentives. Low balances are free, but hoarding large amounts is penalized. Lucas: Precisely. And that gives them a tool to influence the marginal propensity to consume. If the economy needs stimulus, they lower the threshold or make the negative rate steeper. If they need to cool things down, they raise the rate on holdings. Luna: But there's another dimension: cross-border payments. A CBDC could potentially bypass the correspondent banking system and make international transfers instant and cheap. That has monetary policy implications too — it could reduce the demand for foreign reserves, or even challenge the dollar's dominance. Lucas: China's digital yuan is already being tested for cross-border use in Hong Kong and with Thailand and the UAE. If a digital yuan becomes widely used for trade settlement, that could reduce reliance on the dollar in global payments. But that's a longer-term play. Luna: Let's come back to the domestic policy angle. What evidence do we have so far that CBDCs actually affect behavior? The pilots are still limited. Lucas: Early data from the digital yuan pilots suggests that people do spend the 'programmable' red packets more quickly than regular cash. In one experiment, users who received digital yuan with a 7-day expiration spent nearly 90 percent of it, compared to about 40 percent for an equivalent cash gift. So the mechanism works. Luna: But that's a small-scale pilot. Scaling that to the entire economy is a different challenge. You need merchants to accept it, you need digital literacy, and you need to manage the risk of runs on the banking system. Lucas: Which is probably why central banks are moving cautiously. The IMF has warned that a poorly designed CBDC could increase the risk of bank runs, especially during a crisis when people might shift deposits into the perceived safety of the central bank's digital currency. That's a real concern. Luna: So there are design choices that can mitigate that. The ECB's limit of 3,000 euros per person is one. Another idea is to make CBDC non-interest-bearing, so it's less attractive as a store of value. Lucas: But if it's non-interest-bearing, you lose the ability to use negative rates as a policy tool. So there's a trade-off between financial stability and policy efficacy. Luna: And that's the conversation happening in central banks right now. The Bank of Japan, the Riksbank, the Fed — they're all weighing these trade-offs. Lucas: Speaking of which, I think it's worth noting that for all the talk, the Federal Reserve has been notably cautious. They released a discussion paper back in 2022, but there's no formal pilot yet. The U.S. seems to be taking a 'wait and see' approach, partly because the existing payment system is already efficient, and partly because of the political sensitivities. Luna: Yeah, and the political dimension is huge. In the U.S., any hint of the government tracking transactions is a lightning rod. So the Fed has emphasized that any CBDC would be 'intermediated' — meaning banks and fintechs would handle customer-facing services, not the Fed directly. Lucas: That's the model most advanced economies are leaning toward: a two-tier system where the central bank issues the digital currency, but private institutions manage the wallets. That preserves the role of commercial banks and addresses some privacy concerns. Luna: But it also means the central bank doesn't have as much control over programmability. If a bank offers a wallet with a negative interest rate, customers might just switch to a bank that offers a better rate. So the policy transmission might be weaker. Lucas: Right. So the degree of control depends on the architecture. In a direct CBDC model, the central bank has full control. In a two-tier model, it's more indirect. And many countries are still deciding which path to take. Luna: It's also worth considering the impact on monetary policy in emerging economies. In countries with high inflation and unstable banking systems, a CBDC could provide a safe digital store of value. But it could also accelerate dollarization if people prefer to hold a foreign CBDC like the digital yuan over their own currency. Lucas: That's a real risk. The IMF has flagged that 'digital dollarization' could undermine monetary sovereignty in smaller economies. If people can easily hold digital dollars or digital yuan, why hold the local currency? That puts pressure on the central bank's ability to set interest rates independently. Luna: So there's a geopolitical layer too. Countries that issue CBDCs early might gain influence over global payments standards and monetary architecture. Lucas: No question. That's part of why China is moving so aggressively — they see it as a strategic advantage. The digital yuan might not replace the dollar anytime soon, but it could carve out a significant role in Asian trade and finance. Luna: And that brings us back to the core question: will CBDCs actually make monetary policy more effective? Or are they mostly a payment system upgrade? Lucas: I think the honest answer is: we don't know yet. The potential is there — programmable money, direct transmission of interest rates, faster stimulus. But the risks are real too. Banking disintermediation, privacy erosion, digital runs. And the technology is still immature in many cases. Luna: So it's a tool under development. Central banks are essentially building an airplane while flying it. Lucas: That's a great way to put it. And the design choices they make now — how much privacy, how much programmability, how much bank involvement — will determine whether CBDCs become a powerful new instrument or just a footnote in monetary history. Luna: It's fascinating. And for listeners who want to keep up, I'd recommend following the work of the Bank for International Settlements. They publish some of the most accessible research on this. Lucas: Absolutely. And if walking through the economy with us has made something click, or if you appreciate that we keep these episodes free of ads and paywalls, you can support the show at buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. We don't run ads, and listener support is what keeps it that way. Luna: It's a small gesture that makes a big difference for us. So if you're able, we appreciate it. Lucas: Now, back to the digital frontier. One of the most intriguing experiments is happening in Nigeria with the eNaira. They've had mixed results, but it's a real-world test of how a CBDC works in a high-inflation, low-trust banking environment. Luna: And it's not going great. Adoption has been low — less than one percent of the population — partly due to poor internet access and distrust of the government. So it highlights that technology alone isn't enough. Lucas: Exactly. The success of a CBDC depends on design, trust, and infrastructure. No central bank can just flip a switch and have it work. But the direction is clear: digital currencies are coming. The question is how they'll shape monetary policy in the 2030s. Luna: And it's a question we'll keep following. Thanks for joining us on this deep dive. Lucas: Thanks, Luna. And to our listeners, we'll see you next time.