Working Paper: CEPR ID: DP15619
Authors: Harald Uhlig; Taojun Xie
Abstract: The rise of digital currencies may result in domestic parallel currencies. Their exchange rate shocks will present a new challenge for monetary policy. We analyze these issues in a New Keynesian framework, where firms can set prices in one of the available currencies. Price rigidity translates a one-time appreciation of a parallel currency into persistent redistribution towards the dollar sector output and inflation. The persistence lasts longer if the central bank targets "dollar"-sector inflation, rather than inflation across all currency sectors. An increase in dollar price rigidity may lead to a decrease rather than an increase of the non-dollar sector.
Keywords: digital currency; currency choice; monetary policy; sticky prices; new keynesian model
JEL Codes: E52; E30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exchange rate shocks (F31) | output (C67) |
| exchange rate shocks (F31) | inflation (E31) |
| dollar price rigidity (F31) | nondollar sector's economic activity (F69) |
| central bank targets dollar-sector inflation (E52) | persistence of effects from exchange rate shocks (F31) |
| central bank targets aggregate inflation (E52) | persistence of effects from exchange rate shocks (F31) |