Working Paper: NBER ID: w28300
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 currencies; monetary policy; exchange rate shocks; New Keynesian framework
JEL Codes: E30; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| one-time appreciation of a parallel currency (F31) | persistent expansion in the dollar sector (F31) |
| one-time appreciation of a parallel currency (F31) | persistent decline in the nondollar sector (F65) |
| price rigidity in the nondollar sector (F31) | larger impact on overall economic dynamics (F69) |
| monetary policy specification (E52) | dynamics of nominal interest rates and output (E43) |
| increase in nominal interest rates (E43) | decrease in aggregate output (E23) |
| price flexibility (D41) | choice of pricing currency by firms (F31) |