Money Velocity, Digital Currency and Inflation Dynamics in Indonesia
Variations in money velocity play a significant role in shaping inflation dynamics, particularly in economies transitioning toward digital currencies like Indonesia. Incorporating a money-velocity term into a New Keynesian Phillips Curve (NKPC) within a small-scale DSGE model calibrated to Indonesia reveals that changes in velocity have measurable macroeconomic effects. A 10% decline in money velocity—such as that induced by the introduction of a central bank digital currency (CBDC)—can reduce inflation by 0.6% to 1.7%, while an equivalent rise in velocity increases inflation by the same range. Shocks to velocity also account for a notable share of output-gap and interest-rate fluctuations. Modeling a CBDC as a technological innovation that lowers transaction costs suggests long-run benefits, including a 0.8–1% increase in real GDP and lower inflation and interest rates. These outcomes depend on the monetary-policy stance, emphasizing the need for coordinated policy implementation. For Indonesia, where cash remains widely used, incorporating money-velocity dynamics into macroeconomic modeling is essential, and CBDCs could serve as a new policy tool to stabilize inflation and support sustainable economic growth.