Central banks worldwide are embracing digital technology as they edge closer to launching their own digital currencies. How will this affect monetary policy in the future, particularly in emerging markets where many people lack access to bank accounts?
We believe that as central bank digital currencies (CBDCs) are adopted in these countries, more people will become directly exposed to interest rate decisions and monetary policy’s power will strengthen. This could help emerging markets’ monetary policy move towards levels of efficacy seen in developed markets.
Monetary policy affects most people in emerging markets only through indirect channels – such as inflation and the exchange rate – because many people lack access to a bank account. Moreover, many developing economies prefer to keep currency fluctuations within a band pegged to the currencies of their major trading partners to maintain competitiveness.
This leaves output and inflation as the main avenues through which most citizens are affected by monetary policy. Although the effect on output from monetary policy changes helps employment, the consequences of inflation are felt most by those outside the financial system, particularly those who cannot easily protect the value of their savings.
By contrast, policy rates in developed markets influence much of the population through interest rates on savings accounts, financial instruments and loans. This difference is the key reason monetary policy in developed markets is more effective at stabilising the business cycle and inflation.
Our estimates show the effect of monetary policy on output is two‑thirds more powerful in a country with high financial inclusion relative to one with low financial inclusion.
Emerging-market CBDCs now in circulation, such as the Bahamian sand dollar, let people access banking services with the ease of opening CBDC accounts. Interest rates on these accounts could have greater influence on account holders’ spending decisions. Therefore, central banks will be able to better mitigate shocks and reduce economic volatility.