Optimal Central Banking Policies : Envisioning the Post-Digital Yuan Economy with Loan Prime Rate-Setting

We develop a DSGE model with cash and digital currency to study the financial stability properties of two potential central banking policies in China. Specifically, a Loan Prime Rate (LPR)-setting policy function and central bank digital currency (CBDC) implementation are examined. Distinguish between a benchmark model and a "Post-CBDC world", we Bayesian-estimate the model. Post-CBDC implementation, we find macroeconomic variables to display greater procyclicality to real shocks. However, we also find a potential LPR-setting policy to exhibit an improved stabilization property in the post-CBDC world. We uncover an optimal design of LPR policy function, which targets more specifically housing and capital asset markets, as well as the growth in CBDC. This suggests a potential policy complementarity between these two seemingly unrelated central banking policies in the financial stability agenda of China going forward