Impact Evaluation of Scenario with Local Currencies: DSGE Model

This paper presents a dynamic stochastic general equilibrium model developed to conduct a monetary analysis of a scenario with local currencies. The popularity of the alternative currency initiatives has remarkably increased during the last three decades. Despite their widespread proliferation with thousands of them currently circulating, there is a lack of quantitative analysis. This absence worsens the ability of central banks to choose the most appropriate position towards such movement. Presented study proposes an impact evaluation of these initiatives with a unique New Keynesian version of DSGE model extended for capital and labor market along with comparison of different monetary policies from a side of the local currencies. Co-existence of multiple currencies enters the model in the form of a Dixit-Stiglitz index. Simulation of the model suggests a positive effect of the alternative currencies in terms of increase of income but also inflation rate in absolute terms. This outcome appears to be highly sensitive to monetary policy from the side of issuers of the local currencies. The aim of this study is to construct a New Keynesian version of a DSGE model for impact evaluation of local currencies. This model simulates a local economy within the United States with an assumption of price and wage stickiness. Monopolistic competition between firms as well as on the labor market allows a derivation of the traditional New Keynesian Phillips curve. The appearance of the model assimilates the classical New Keynesian DSGE model of Galí (2008) enhanced for a capital variable. In contrast to this traditional textbook model, a local currency variable enters the utility function of the model in a form of a Dixit-Stiglitz aggregate famously applied for consumption bundle. Wage and price setting behaviors are in turn affected by the existence of multiple currencies. In the end, two potential monetary policies of issuing institutions for local currencies allow a comparison these policies might have on the circulation of the local currency as well as on the local economy itself. This model may additionally serve as a tool for a researcher to answer inquiries about the macro impact of these currencies on an economy. he dynamic stochastic general equilibrium model stands for the applied method to model a local currency movement simulated in the program Dynare. The influential book of Galí (2008) inspires the construction of this version of New Keynesian model with price and wage stickiness along with the existence of monopolistic competition between firms and on labor market. The model is further modified to incorporate features characteristic for local currency systems next to circulation of a legal tender. The introduction of local currencies into the model takes a form of a Dixit-Stiglitz index. A representative agent opts between a continuum of various complementary currencies for trading purposes while representative firm makes a decision over currency for price and wage denomination taking into consideration behavior on labor as well as capital market. Classical New Keynesian Phillips curve allows a simple simulation and comparison of the result to the original model of Galí (2008) without the co-existence of national currency aside local currencies. Next, I introduce adjustment costs in association with using new local currency, network externality variable and social capital. The intuition behind incorporating social capital stands behind the idea of local currencies to improve social network within a community. For this reason, local currencies enter an agent’s utility function being a function of social capital. Two different common monetary policies have been selected for the issuing institutions of local currencies. An issuer is assumed to either maximize profit or to allow money demand to react to money supply without her intervention. Central bank issuing the national currency is assumed to follow the famous Taylor rule. Concerning selected monetary policies profit maximization has a destabilizing effect on the economy. Monetary policy of elastic money demand in reaction to money supply changes provides more reasonable results. In this scenario, an increase in demand for a local currency in presence of adjustment costs drop results in a raise of the output variable along with higher inflation rate. In response, wages tend to decrease. The growth of demand for a local currency allows producers to request higher prices for their products. At the same time, employees are willing to work for relatively lower wages. Inflation rate of the local currency increases as well as inflation rate of the legal tender. In response, upward movement of interest rates stabilizes the economy and results in a continuous return of other variables to their previous steady-state levels. In conclusion, a local currency movement seems to favor the aggregate output of a local economy. This result could be of an interest to policy-makers whether to support a local-currency movement in their community.