Money velocity, digital currency, and inflation dynamics

Danny Hermawan, Denny Lie, Aryo Sasongko and Richard I. Yusan

No 2023-01, Working Papers from University of Sydney, School of Economics

Abstract: This paper empirically investigates the impact of transaction cost-induced variations in the velocity of money on inflation dynamics, based on a structural New Keynesian Phillips curve (NKPC) with an explicit money velocity term. The money velocity effect arises from the role of money, both in physical and digital forms, in reducing the aggregate transaction costs and facilitating purchases of goods and services. We find a non-trivial aggregate impact in the context of the Indonesian economy: our benchmark estimates suggest that a 10% decrease in money velocity, which might be facilitated by a new digital currency (e.g. CBDC) issuance, would reduce the inflation rate by 0:6-1:7%, all else equal. Using the estimates and within a small-scale New Keynesian DSGE model, we analyze the potential implications of a CBDC issuance on aggregate fluctuations. A CBDC issuance that conservatively lowers the velocity of money by 5% is predicted to permanently raise the GDP level by 0:8% and lower the inflation rate by 0:8%. Both nominal and real interest rates are also permanently lower. Our findings imply that central banks could potentially use CBDCs as an additional stabilization policy tool by influencing the velocity.

Keywords: inflation dynamics; transaction cost; velocity of money; digital money; digital currency; central bank digital currency (CBDC); aggregate fluctuations (search for similar items in EconPapers)
Date: 2023-03
New Economics Papers: this item is included in nep-ban, nep-cba, nep-des, nep-dge, nep-fdg, nep-mac, nep-mon, nep-pay and nep-sea
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Working Paper: Money velocity, digital currency, and inflation dynamics (2023)
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