Central Bank Digital Currency with Adjustable Interest Rate in Small Open Economies

Abstract

We examine the economic consequences of an interest-bearing design of the Central-Bank Digital Currency (CBDC), and extend the discussion to an open-economy context with trade and capital flows. We use a dynamic stochastic general equilibrium (DSGE) model to simulate a baseline scenario with only a primary monetary policy rule, and two counter-factual scenarios with a primary monetary rule together with a secondary CBDC rule associated with adjustable interest-bearing CBDC — the price rule or the quantity rule. Our simulations show that 1) CBDC with an adjustable interest rate is welfare-improving; 2) a quantity rule delivers the best welfare outcome for society, but with uneven distributional effects between households and financial investors; 3) exchange rate movements and inflation are more stable with the adjustable interest rate; 4) imperfect substitutability between CBDC and bank deposits is the key for the effectiveness of using the CBDC as a secondary monetary policy instrument.

Keywords: CBDC, DSGE, monetary policy, cash, blockchain, distributed ledger

JEL Classification: E41, E42, E43, E52, E58, F31, F41