This paper investigates the effect of financial instability on the design of monetary policy rule for a small open economy. We find evidence that optimal monetary policy rule reacts directly to financial imbalances and, as a result, to the real exchange rate movements. However, optimal rule...

The outcome of a speculative attack on the foreign exchange rate can be classified into three cases: (i) immediate depreciation of the nominal exchange rate, (ii) successful defense, or (iii) failed defense. This paper explores which of these outcomes yields the lowest cost in terms of output...

What is the effect of Central Bank Digital Currency (CBDC) on financial stability? We answer this question by studying a model of financial intermediation with an endogenously determined probability of a bank run, using global games. As an alternative to bank deposits, consumers can also store...

Digital currencies provide a potential form of liquidity competing with bank deposits. We introduce stable digital currency into a macro model with a financial sector in which financial frictions generate endogenous systemic risk and instability. In the model, digital currency is fully...

Fractional reserve regimes generate fragile banking, and full reserve regimes (e.g., narrow banking) remove fragility at the cost of suppressing the role of banks as lenders. A Central Bank Digital Currency (CBDC) could provide safe money, but at the cost of potentially disrupting bank lending....