Page 109 - Azerbaijan State University of Economics

Nazim Hajiyev, Daniyar Aliyev: A DSGE Framework For Sovereign Digital Currency
Adoption in Small Open Economies: Macro-Financial Channels, Bank Intermediation, and
Policy Trade-Offs

● Commit to recycling. Establish transparent rules for how the central bank will
use incoming SDC liabilities (asset purchases, targeted lending) to preserve credit
flow, and communicate them clearly to avoid destabilizing expectations.
● Coordinate with fiscal authorities. Recycling through asset purchases may have
fiscal implications—coordination ensures sustainable balance-sheet policies.
● Monitor market power. Where banking sectors show concentrated deposit
market power, modest SDC remuneration can yield welfare gains by disciplining
rates without causing disintermediate.
● Gradualism and pilots. Pilot SDC layers (tiering, capped wallets) and monitor
bank funding elasticity before scaling up.

CONCLUSION AND FURTHER RESEARCH
This paper develops a compact DSGE framework for a small open economy to
analyze the macro-financial consequences of sovereign digital currency (SDC)
adoption. The model highlights two central, interacting forces. On one hand, a well-
designed SDC improves payments efficiency and can discipline banks’ deposit market
power, raising household returns and delivering liquidity-service gains. On the other
hand, SDC attractiveness can induce deposit substitution, erode banks’ funding, and—
absent offsetting actions—contract credit and amplify exchange-rate and capital-flow
volatility in open economies. The net welfare effect depends critically on SDC design
(remuneration, tiering), banking-sector characteristics (intermediation capacity,
market power), and the central bank’s recycling commitment.

For small open economies with relatively shallow banking sectors, the model’s policy
message is cautious: modest or tiered remuneration combined with credible recycling
and clear operational rules best balance liquidity benefits against the risks to
intermediation and financial stability.

The main policy implication is practical: start conservatively (limited remuneration
and holding caps), make recycling provisions explicit, and phase expansion through
pilots while monitoring bank funding elasticities and cross-border use.

Further research
The model points to a number of promising extensions and empirical exercises that
would strengthen understanding of SDCs in small open economies:

1. Endogenous bank risk and macroprudential interaction. Model how banks
respond to margin pressure by altering risk-taking and how macroprudential
tools (countercyclical capital buffers, loan-to-value limits) interact with SDC
design choices.

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