Economic uncertainty, central bank digital currency, and negative interest rate policy

Abstract

The COVID-19 outbreak has brought unprecedented social attention to economic uncertainty and negative interest rate policy (NIRP). How does uncertainty affect economic activity, and how effective is a NIRP based on central bank digital currency (CBDC)? To answer the two questions, we constructed a dynamic stochastic general equilibrium (DSGE) model that accommodates sticky prices and wages. The results indicated: (i) Economic uncertainty has substantially reduced investment, output, wage, and loans, which increases unemployment risk. In the short term, it has triggered impulsive consumption by households, while consumption has fallen into a slump in the long run. (ii) After suffering an uncertainty shock, the economy entered short-term stagflation and long-term deflation. The short-term stagflation was mainly caused by resident wage adjustment, and the long-term deflation was due to the decline in effective demand caused by unemployment risk. (iii) CBDC could eliminate the zero lower bound (ZLB) constraint, thereby improving the effectiveness of NIRP. Compared with traditional currency, CBDC-based NIRP could more effectively smooth macroeconomic fluctuations and alleviate the negative impact of an uncertainty shock, which is more conducive to restoring market confidence and promoting economic recovery.