The sudden increase in inflation was not a result of a policy mistake but a coordinated convergence of a set of unprecedented macroeconomic shocks:

Standard monetary theory often references the Taylor rule as a guide for interest rate adjustments, expressed as:r=p+0.5y+0.5(p−2)+2

In this model, r is the proposed nominal interest rate, p is the inflation rate, and y is the output gap. During the period from 2021 to 2023, the difference between the suggestion made by the Taylor rule and actual rates attained a historically high value.¹² Central banks deliberately chose to operate “behind the curve” to ensure a strong recovery in the labor market. This has been argued to have led to the inflationary expectation becoming “unanchored”¹³ among many economists. However, a crucial task is yet to be accomplished regarding the definition of the natural interest rate (r*)—the level where interest rates do not stimulate or slow down economic activity. This is a topic of debate regarding a potential increase in r* influenced by¹⁴ increased public debt, high transitional costs for a green transition,¹⁵ or a transition from “offshoring” to “friend-shoring,” which could potentially ensure supply-chain integrity.¹⁶

Meanwhile, with the real wages affected by inflation, the labor forces in various industries demanded increased nominal wages, thus raising concerns about a “wage–price spiral.”¹⁷ During this time, there was a significant change in Phillips curves, whereby the relationship between unemployment and inflation became less linear compared to the earlier decades.¹⁸ Central banks have had to adapt to new frameworks to capture the non-linearities in the labor market dynamics while trying to manage a “soft landing,”¹⁹ as represented in Figure 1.

Source: The figure illustrates the mutually reinforcing interaction between wage growth, production costs, and inflation expectations, along with the transition from a flatter Phillips curve during the Great Moderation to a steeper curve in the post-pandemic period. Conceptual representation by the author.

The wage–price spiral is said to form a self-reinforcing feedback cycle in which an uncompetitive labor market allows workers to successfully make claims for higher nominal wages, leading in turn to increased costs of production for firms and, consequently, inflationary perceptions become de-anchored as workers make new wage claims, fueling endless wage–price spirals in turn.¹⁷ The structural change is represented in this way through Phillips Curves, transformed in their shape and form over time from a traditional “flat profile” during the great moderation period to an excessively steep profile in this post-pandemic period in particular,^18,19 in such a way that any slight cut in unemployment is now accompanied by excessively aggressive inflation reactions, pushing central banks toward drastic interest-rate increases in order to pursue instead a “soft-landing strategy” toward achieving 2% inflation without having any inflationary spark accelerate unemployment rates toward recession peaks.

The literature was selected based on its relevance to the evolution of central bank mandates and the digitalization of finance.

The empirical analysis focuses on the “Pandemic Pivot” period, primarily spanning 2020–2024, with the 2010–2019 decade serving as a baseline for the “Great moderation.”

To analyze the “behind the curve” phenomenon, the paper evaluates the gap between suggested and actual nominal interest rates using the Taylor Rule formula:r=p+0.5y+0.5(p−2)+2

The findings are reproducible through the use of publicly available datasets from the Federal Reserve Economic Data (FRED) and the BIS Statistics Warehouse. Qualitative assessments regarding CBDC architectures and climate risks are based on comparative analysis of the “two-tier” distribution models and the NGFS (Network for Greening the Financial System) climate stress test frameworks.

The pressure to issue a CBDC is fueled by three major strategic purposes. First, in developing countries, digital currencies are viewed as a solution to financial inclusivity, considering that they form a cost-effective and secure mode of exchange.^23,24 Second, in developed countries, digital currencies are used as a shield for their unit of accounts from developing global “stable coins” and decentralized finance platforms that have the ability to threaten their power over money matters.^25,26 Third, in the wholesale sector, their coupling with DLT is set to give an entirely new life to international cash transfers by virtue of their ability to support “atomic settlement,” cutting down the days needed in transits facilitated by traditional systems by as much as seconds.^27,28

The presence of a CBDC changes the standard monetary transmission mechanism. To examine the trade-off between improved transmission and financial stability, we set up a stylized macro-financial model in which the central bank sets the CBDC interest rate i^CBDC.

D denotes commercial bank deposits and C denotes CBDC balances. The household utility function includes the liquidity services provided by both:U=∫0∞e−ρt[u(xt)+v(Dt,Ct)]dt Where v (D, C) represents the elasticity of substitution between private and public money. If i^CBDC ≥ i^Deposit, then there is a “corner solution” where all deposits are siphoned off, that is, D → 0, which collapses the bank lending channel. To avoid this, the IPF adds the constraint:iCBDC={i⁎−δifC≤C¯−∞ifC>C¯ where δ is a safety spread and C bar is a quantitative holding cap (e.g., €3,000). This ensures v (D, C) remains imperfectly substitutable, preserving the credit multiplier.

Any systemic risk with regard to the disintermediation of banks will be a natural consequence of such a shift toward a digital currency system. If households perceive a CBDC as more convenient or safer than bank deposits, it is quite conceivable that there could be a run from one type of deposit to the other.²⁹ This would mean a siphoning off of liquidity from the private banking system, thereby increasing the cost of funding for loans, which would impact the credit multiplier for economic growth.^30,31 To translate this framework into practical guidance, model simulations indicate a strict “two-tier” distribution model. In this framework, the central bank only delivers the wholesale ledger and settlement layer, while the retail interface, KYC, and customer service are handled by commercial banks and regulated payment providers. Moreover, to avoid “digital bank runs,” the policy must adopt remuneration caps or tiering. This requires a zero or low interest rate on retail balances up to a certain threshold (e.g., €3,000), with penalty rates or hard caps on balances above that threshold to ensure that the CBDC is a medium of exchange and not a store of value that competes with commercial bank deposits.^32,33,34,35 Such digitalization of money also has implications related to the “weaponization of finance,” or the geopolitical leverage of payment systems and reserve access. Following the freezing of Russian central bank reserves in 2022, “confiscation risks” have accelerated interest in CBDCs and other settlement assets. Yet, primary data seems to reveal a more complex reality than that of “de-dollarization” and related geopolitical implications. According to COFER data from the IMF (2025), the share of the US dollar in global allocated funds has been experiencing a gradual decline, or “stealth de-dollarization,” from 70% in 2000 to 57%–58% in 2025. However, this has not been replaced by any other currency, such as the Renminbi, which holds less than 3%. Rather, diversification has moved into “non-traditional” currencies (such as the Australian and Canadian dollars, and the South Korean won) and gold, with the World Gold Council noting that central bank purchases have broken records, exceeding 1000 tons per year in 2024. BIS analysis supports the argument that the dollar's “exorbitant privilege” is maintained by its deep liquidity and the lack of credible alternatives that can offer the same “safe asset” role, indicating that the transition toward a multipolar monetary system is slow and hampered by strong network effects.^36,37 (Table 3).

The central banks have increasingly come to understand that climate change should not only be considered from a political externality perspective but also as one of the largest threats to their stability.³⁸ To be specific, actionable advice in this area demands the establishment of a “clear line of demarcation” between supervisory assessment and active allocation in order to prevent “mission creep.” Moreover, the standards set in the area of climate stress testing should be codified as mandatory disclosure requirements, specifically in relation to the resilience of bank capital in the face of “Green Swans.” Conversely, active balance sheet policies such as Green QE should be circumscribed by principles of “market neutrality” unless an explicit market failure is identified. Finally, in order to preserve the institutional mandate in the area of climate change, central banks should prioritize climate stress testing as a risk management tool, reserving the area of carbon pricing and industrial subsidies to the fiscal authorities.^{39,40,41,42,43,44,45} (Table 4).

It is widely acknowledged that there is an academic consensus on the serious implications of the use of unorthodox monetary policies on an ongoing basis.⁴⁶ Quantitative easing, per se, has always led to the expansion of asset values (equities and property) to activate the “wealth effect,” but with ownership of assets being mostly concentrated in the top household decile, it is increasingly contributing to worsening wealth disparities.^47,48 By contrast, the inflation tax due to post-pandemic price accelerations is mostly hitting poor households, for whom larger components of their salaries are spent on inelastic commodities such as energy and food.⁴⁹ It is under this stress that Central Banks are forced to assume an increasingly “inclusive” stance toward interest-rate cycle impacts on various socio-economic groups with regard to ensuring their institutional autonomy under public support over time.⁵⁰ In order to reach the desired depth and intensity, we would supplement the requested chapters with an analysis of chapter 5 on the “Fiscal-Monetary Nexus (FMN) and how governments and central banks interact today,” and chapter 6 on the Geopolitics of Finance.

Thus, as governments began to execute major relief efforts, central banks began to encourage this expenditure by maintaining low borrowing costs in order to finance it on their side. This ends up causing the situation of fiscal dominance, where the need to finance the major debt in the economy of the country may tend to affect the ability of the central bank to set interest rates.^52,53 This ends up affecting the major mandate of the central bank as the primary goal, which is to maintain the country's price level stability. However, the exit strategy from this “pandemic-induced” accommodative stance is limited by the sheer size of central banks' balance sheets. As of early 2025, the aggregate balance sheet sizes of these “Big Four” central banks (Fed, ECB, BoJ, and BoE) are still relatively high.

Balance sheet statistics (USD Trillion Equivalent):

Moreover, the pace of quantitative tightening (QT) has to be balanced with r*. Current HLW (2023/24) estimates indicate that while r* has indeed moved higher from its 2019 trough, it remains structurally lower than nominal rates. Therefore, it is argued that central banks are maintaining a “restrictive” policy stance. For instance, with respect to the US, HLW estimates r* at 0.9% – 1.1% (in real terms) based on its COVID-19 adjusted estimate. Nominal rates of 4% imply a significant positive real rate gap, which may result in over-tightening if supply-side shocks persist.⁵⁴

It has been noted that the central banks cannot afford to enter a “debt trap,” given the unprecedented levels of public debt across the globe, which may result in a fiscal crisis in the case of strong monetary policy measures in the highly leveraged economies.⁵⁴ In order to prevent this phenomenon of fiscal dominance, new coordination protocols are necessary. These should involve the adoption of so-called “debt anchor rules” whereby support by the central bank during crises depends on the adoption by the government of a transparent medium-term consolidation plan. Moreover, the start of QT should be subject to rules based on the level of market depth rather than rigid calendars. This is because the progress of QT should be linked to the level of liquidity in the economy, such as the bid-ask spreads in the sovereign bond market, to prevent the triggering of a so-called “taper tantrum” and a systemic surge in borrowing costs that would force the central bank to give up its inflation-fighting mandate too quickly.^55,56 Crucially, these cycles of tightening are calibrated based on the estimation of r*, that is, the long-run natural rate of interest consistent with full employment and stable inflation. Measurement of r* has been achieved through semi-structural models, which filter out r* from GDP growth rates and inflation. The Laubach–Williams (LW) model forms the base of these measurements, where r* is specified as a function of trend potential GDP growth and other persistent factors through a state-space approach. The Holston–Lauba–Williams (HLW) model is an extension of this model, which incorporates the US, Canada, and Euro Area economies. Subsequently, this model has been modified since 2020 to reflect the volatility of the period. Whereas the traditional HLW estimates implied a steady path of r* to zero, the post-pandemic adjustments (HLW 2023) incorporate time-varying volatility and “COVID-adjusted” potential output series to separate one-off price shocks from sustained changes in the neutral interest rate. This requires policymakers to balance these structural estimates with market expectations derived from surveys to assess whether the “Great Moderation” of ultra-low interest rates has actually passed or merely been temporarily paused.⁵⁷

“The increasing application of the US dollar and the Swift system as “weapons of geopolitics” is accelerating the quest for an alternative.” Numerous states are currently researching “friend-shoring” or “final settlement in local currencies” in order to “decrease vulnerability to events in the world of international finance.”⁵⁸ The geopolitical changes represent an essential area in the evolution of international CBDC-bridges like “project mBridge.” This solution provides the means to “facilitate international transactions in digital form, independently of the underlying financial infrastructure supported in North America.”⁵⁹ (Table 6).

What is being observed is the “early stages of a shift toward a ‘multipolar’ monetary system in which a greater role for several ‘major’ currencies: The euro, the renminbi, and even gold could become even more important than they were in a reported ‘dollar-centered’ system even as ‘The U.S. dollar continues to be the preeminent international currency’ but a decreasing part of ‘international reserves.’” The shift represents a challenge to central banks in a “flow of capital shaped more by views of national security than by interest rate differentials.”⁴⁷