Central Bank Digital Currency and Financial Frictions in Business Cycle and Monetary Policy Analysis
Abstract
I explore how the introduction of a retail central bank digital currency (CBDC) affects the business cycle and welfare in the presence of financial frictions. In this paper, CBDC serves as an imperfect substitute for the private liquidity service, and it is the only household asset free from a default risk of the financial sector. Two CBDC regimes are discussed: intermediated CBDC and independent CBDC. Under the two regimes, I analyze second moments, business cycle propagation, and consumption-equivalent welfare with different CBDC monetary policy rules. The results show that the introduction of CBDC mitigates business cycle fluctuations and improves consumption-equivalence welfare across all CBDC economies compared to the non-CBDC baseline. The stabilization effects work differently among CBDC economies through a balance sheet channel and a substitution channel. The most significant improvement comes from the intermediated regime with a CBDC interest rule, in which mitigation effects from both channels are effective in response to macroeconomic shocks.