Further progress in digital money, electronically stored monetary value, may enable pricing in units of any currency in any country. This paper studies monetary policy in such a world, using a two-country open economy model with nominal rigidities. The findings are three-fold. First, domestic monetary policy becomes less effective as digital dollarization - pricing using digital money, denominated in and pegged to a foreign currency - deepens. Second, digital dollarization is more likely to occur in a smaller country that is more open to trade and has a greater tradable sector and stronger input-output linkages. Third, monetary policy can facilitate or discourage digital dollarization depending on its stance on the stabilization of macroeconomic variables.
Keywords: Digital money; monetary policy; dollarization
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.