Central Bank Digital Currency, Inflation Tax, and Central Bank Independence

Abstract

Can introducing Central Bank Digital Currency (CBDC) improve social welfare? We construct a dual currency model to study whether introducing CBDC with a record- keeping technology can reduce tax evasion incentives, and further achieve a better al- location than in a cash-only economy. In our model one type of agents can evade the sales tax by using cash whereas the other type of agents cannot. If the sales tax is perfectly substituted by the inflation tax, then there is no way to evade taxes. How- ever, if the sales tax is required for maintaining the central bank independence, there arises an inefficiency associated with tax evasion in a cash-only economy. Introducing CBDC with a positive interest can correct this distortion by discouraging tax evasion, rewarding tax payment, and raising the sales tax collection.

Keywords: Cash, Central Bank Digital Currency, Monetary Policy, Fiscal Policy, Tax Evasion

JEL Classification: E31, E42, E58, H21, H26