Thanks to blockchain technology, the future of banking may evolve without traditional intermediaries. In this context, central bank digital currencies (CBDCs) and stablecoins issued by BigTech companies are emerging as the main competitors in the new monetary era. Against this background, the present study used a dynamic stochastic general equilibrium (DSGE) approach to model the economic effects of issuing Iran’s CBDC (i.e., Digital Rial) over the period from 2009 to 2022 (1388–1400 in the Iranian calendar). In the model, Digital Rial was assumed to be an account-based, widely accessible, and interest-bearing form of money that would complement cash. The model results indicated that the issuance of Digital Rial could diversify the Central Bank’s policy instruments and enhance the effectiveness of monetary policy in response to both supply and demand shocks. Issuing an appropriate amount of Digital Rial, particularly in the context of stagflation in Iran’s economy, could enable the Central Bank to implement disinflationary policies while mitigating their adverse effects on the production. Moreover, the dynamics of deviations in transaction costs constituted the most important factor affecting the monetary transmission mechanisms. Finally, given the growing adoption of electronic payment solutions in Iran and the resulting decline and eventual obsolescence of cash usage, the Central Bank could use Digital Rial to provide liquidity services more effectively while maintaining a direct relationship with the public.
Introduction
The emergence of Bitcoin during the 2008 financial crisis brought about significant changes in the financial and banking sectors and introduced a range of new solutions and concepts. Since the underlying idea behind many of these innovations, including Nakamoto’s original proposal, is to enable transactions without the involvement of a third party, central banks around the world have closely monitored these developments. In fact, the declining role of cash in the payment system may pose a challenge to central banks’ sovereignty. In response to these developments, central banks have sought to improve the effectiveness of their operations through new initiatives. One such initiative is the introduction of central bank digital currency (CBDC) as a new monetary instrument.
Although the introduction of CBDCs could provide central banks with new capabilities, questions and uncertainties regarding their economic consequences have led many countries to adopt a cautious approach rather than introduce them rapidly. In Iran, the issue of CBDCs subsequently entered academic, policymaking, and executive discussions. However, there is a lack of macroeconomic analysis based on formal modeling. In this respect, the present study used a stochastic dynamic general equilibrium (DSGE) model to investigate the effects of issuing a CBDC on Iran’s monetary policy over the period from 2009 to 2022 (1388–1400 in the Iranian calendar).
Materials and Methods
The present study used a DSGE approach to model the effects of Digital Rial on Iran’s monetary policy. In the research model, Digital Rial was treated as a financial asset. Although it is digital, it is denominated in Iran’s legal tender (i.e., the rial). Thus, its issuance would create a liability on the Central Bank’s balance sheet. Digital Rial was also assumed to be an interest-bearing, account-based form of currency.
The model was based on a New Keynesian framework. In order to explain business cycle dynamics in Iran as a developing economy, it incorporated both formal and informal labor markets, labor market rigidities, and transaction costs. The objective was to evaluate the effects of introducing Digital Rial alongside the country’s existing legal tender (i.e., the rial). The analysis also focused on the interaction between Digital Rial and the labor market.
For simplification, the model abstracted from financial intermediaries and assumed that money was entirely created by the government. Household money demand arises from transaction costs, with cash and Digital Rial serving to reduce these costs. Model calibration aimed to minimize the distance between theoretical and observed empirical moments. The remaining parameters were calibrated using a perturbation method based on a second-order Taylor expansion and implemented in Dynare software.
The Iranian economy was analyzed over the period from 2009 to 2022 (1388–1400 in the Iranian calendar). The quarterly data included real consumption, gross domestic product (GDP), consumer inflation, gross fixed capital formation, total government expenditure, and the unemployment rate. The contribution of the informal sector was captured through the labor force participation rate.
Results and Discussion
Applying a demand-side shock showed that an increase in government expenditure led to an increase in output, although it also generated a substitution effect on investment and consumption. A positive demand-side shock was inflationary, as it would increase government expenditure and, consequently, aggregated demand. As a result, the monetary authority was expected to adopt a policy aimed at reducing inflation.
The analysis also yielded insights on the role of monetary balances (both cash and Digital Rial) in the liquidity production function. In the absence of Digital Rial, an increase in the interest rate would raise the opportunity cost of holding cash, thereby reducing the demand for cash. Under the quantitative rule, however, an increase in the supply of Digital Rial would reduce the demand for cash because of the interest earned on Digital Rial. In contrast, under the price rule, adopting the same policy would increase the demand for cash because an increase in the nominal interest rate, together with a decrease in the interest rate paid on Digital Rial, could make cash relatively more attractive. Furthermore, an increase in the interest rate would reduce the demand for Digital Rial balances under both rules, although the decline was greater under the price rule. This effect reflects a response to the deviations generated by transaction costs.
The impulse-response functions indicated that a positive technology shock would increase the demand for inputs by reducing marginal costs. Consequently, the increase in input demand is accompanied by a decline in the unemployment rate. As household income rises, both consumption and investment increase, and the combined effect of these changes would lead to higher demand for monetary balances—including both cash and Digital Rial—in order to reduce transaction costs. The increase in household income and consumption would also lead to higher wages in both the formal and informal sectors. As a result, the labor market could become more attractive, leading to an increase in the labor force participation rate.
Conclusion
The growing adoption of cryptocurrencies among the general public, together with the sharp decline in the use of cash as the primary direct channel of interaction between central banks and the public in everyday transactions, has raised serious concerns about the ability of central banks to influence economic activity through conventional monetary policy. In response, many governments and central banks are seeking to preserve or restore their central role in an increasingly rapidly evolving monetary landscape.
To achieve these objectives, central banks have adopted a broadly similar approach, that is, exploring the potential issuance of CBDCs. On the one hand, considerable uncertainty remains regarding the optimal technical and economic design of such currencies. On the other hand, there is substantial uncertainty about the potential effects of their introduction on the broader economy and the monetary and financial system. These uncertainties have led many countries to adopt a cautious, experimental approach, closely examining the outcomes of similar projects in other countries and drawing on their experiences and strategies. In Iran, the potential issuance of a CBDC is also significant for an additional reason: it may create new opportunities for circumventing the international sanctions through cryptocurrencies.
Having examined the various dimensions of CBDC issuance, the present study developed a DSGE model incorporating Digital Rial. Using quarterly data and calibration parameters relevant to the Iranian economy, the analysis evaluated the effects of issuing Digital Rial as a new instrument of monetary policy. The introduction of supply-side and demand-side shocks made clear that the issuance of Digital Rial has the potential to improve the efficiency and effectiveness of monetary policy.
According to the developed model, the deviations in transaction costs constitute the main mechanism through which the Rial affects the economy, and this new tool can strengthen the possibility of reducing deviations in transaction costs. The results of the model also showed that the higher the reward for holding Digital Rial, the lower the sacrifice ratio (the amount of production that is lost for one unit of inflation reduction)—which is a desirable outcome. Furthermore, the ratio of Digital Rial to GDP should not be excessive. Beyond a certain level, not only does Digital Rial cease to reduce the deviations caused by transaction costs, but it may also exacerbate these deviations and worsen the sacrifice ratio.
Concerning Digital Rial, the Central Bank of Iran should consider the fact that the amount of the bonus awarded for holding Digital Rial and the degree of liquidity would affect the efficiency of Digital Rial. Overall, the issuance of Digital Rial can enhance the effectiveness of the Central Bank’s monetary policy and can be particularly effective in implementing policies aimed at addressing stagflation.