Page 108 - Azerbaijan State University of Economics

THE JOURNAL OF ECONOMIC SCIENCES: THEORY AND PRACTICE, V.82, # 2, 2025, pp. 96-116

Policy rule (heuristic): For small open economies with shallow banking sectors and
moderate external risk premia, the welfare-improvement parameter set typically
satisfies:

1. ∈ [0, − ], where is the policy rate and ≈ 0.5 − 1 percentage point
(the precise value depends on deposit elasticity). This curbs excessive deposit
outflow while retaining some disciplining effect. (Consistent with Garratt &
Zhu, 2021.)
2. Implement tiered holdings with a zero/remuneration ceiling beyond a modest
limit (e.g., fraction of household balances) to prevent wholesale flight.
3. Commit to recycling a nontrivial share γ by ex-ante declaring asset-purchase
or targeted lending operations to restore bank funding during transition.

These heuristics align with central-bank practice suggestions (BIS, 2021; IMF, 2023;
IMF, 2025b) and ensure operational feasibility for small economies with limited deep
financial markets.

ROBUSTNESS AND EXTENSIONS
We discuss three robust checks and extensions that preserve main qualitative
messages:
1. Endogenous bank risk-taking. If banks respond to margin compression by
taking more risk, the contractionary lending effect can be partially offset but at
the cost of greater systemic risk. This introduces trade-offs between near-term
credit availability and long-term stability.
2. Heterogeneous households. Allowing heterogeneity in liquidity preferences and
cross-border access to SDC refines distributional effects; richer households may
substitute more into SDC, altering aggregate outcomes.
3. Partial adoption and fintech. Introducing fintech intermediaries that compete
with banks and SDC (or provide wrappers around SDC) changes equilibrium
margins and can reduce the need for heavy recycling.
All extensions are described in Appendix C and can be implemented within the
model’s structure.

POLICY DISCUSSION: OPERATIONAL CONSIDERATIONS FOR SMALL
OPEN ECONOMIES
Practical takeaways for policymakers:
● Design conservatively. Start with a non-or low-interest SDC with modest
holding limits and limited cross-border usability until operational and regulatory
frameworks mature.

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