Published Papers


This paper analyzes the implications of different models of intermediation, clearing and settlement of central bank digital currency (CBDC) for the ability of the financial system to create money and, through it, to possibly affect financial stability. Only two models have the potential to limit the private sectors’ ability to create money: a model where the central bank directly opens accounts with the public, and a model where the central bank allows intermediaries to perform only custodial activities in CBDC. Under any other intermediation model money can be created inside the financial system by the intermediaries providing payment services associated with CBDC holdings. However, the creation of inside money does not necessarily affect financial stability per se, it does so indirectly by facilitating activities linked to maturity transformation. 


We provide a theory for the collapse in bank-to-bank trade experienced in the United States since the 2007-2009 financial crisis and since the onset of a floor system for monetary policy. We show that the choice of framework to implement monetary policy affects welfare, and that interbank trade is not feasible under a floor system.  Our theory incorporates a key feature of the Federal Funds market: credit is unsecured and, thus, subject to an endogenous borrowing limit. When the punishment for failing to repay loans is permanent exclusion from interbank markets, if interest rates are too low, then the opportunity cost of holding money is also low, and so is the punishment for defaulting on loans. Hence borrowing banks have no incentive to repay their loans, the endogenous borrowing limit is zero and bank-to-bank lending collapses, despite banks still having a need to borrow. We propose a framework of Voluntary Reserve Targets to implement monetary policy that restores an active interbank market, and we provide conditions for it to be welfare improving over a simple reserve remuneration framework, even away from the floor.

Presented at: Macroeconomic Policy Perspectives conference, Minneapolis Fed (USA) organized for a special issue of the Journal of Political Economy Macroeonomics, 18th Annual Cowles Foundation Conference on General Equilibrium, Yale University (USA), University of Wisconsin Madison (USA), University of Wisconsin Madison (USA), European Central Bank (Germany), Federal Reserve Bank of Cleveland (USA), Simon Frasier University (Canada), 2021 SED annual meeting. 



A Central Bank Digital Currency (CBDC) is a form of digital money that is denominated in the national unit of account and constitutes a direct liability of the central bank. We examine the financial stability risks and benefits of issuing a CBDC under different design options. Our analysis is based on lessons derived from historical case studies as well as on an analytical framework that allows us to characterize the mechanisms through which a CBDC can affect financial stability. We further discuss various policy tools that can be employed to mitigate financial stability risks.


Financial activity associated with digital assets has grown rapidly, raising concerns about financial stability risks. This article presents an overview of these risks, adapting the Federal Reserve’s framework for monitoring financial stability in the traditional financial system. The overview reveals that the observed fragility of digital assets is associated with several financial vulnerabilities: valuation pressures of crypto assets, funding risk in most crypto sectors, the widespread use of leverage, and a highly interconnected crypto ecosystem. However, to date, these vulnerabilities have made a limited contribution to systemic risk given that the digital ecosystem is relatively small, is not a major provider of financial services, and exhibits limited interconnections with the traditional financial system.


This note presents a simplifed version of the model of voluntary reserve targets (VRT) developed in Baughman and Carapella (2018), with a Walrasian interbank market. First, the model makes transparent the role of target setting in controlling the market rate. Second, the simplicity of the model allows for an analysis of the interaction between VRT and tolerance bands, which are a common tool for controlling rate variability. We find that the persistent overshooting of interbank rates observed during the Bank of England's experiment with VRT may derive from the interaction between target setting and tolerance bands, a new explanation relative to the literature. We also suggest a simple remedy. 



This paper studies the optimal clearing arrangement for bilateral financial contracts in which an assessment of counterparty credit risk is crucial for efficiency. The economy is populated by borrowers and lenders. Borrowers are subject to limited commitment and hold private information about the severity of such lack of commitment. Lenders can acquire information, at a cost, about the commitment of their borrowers, which affects the assessment of counterparty risk. Clearing through a central counterparty (CCP) allows lenders to mutualize counterparty credit risk, but this insurance may weaken incentives to acquire and reveal information. If information acquisition is incentive-compatible, then lenders choose central clearing. If it is not, they may prefer bilateral clearing either to prevent strategic default or to optimize the allocation of costly collateral.


We develop a parsimonious model to study the effect of regulations aimed at reducing counterparty risk on the structure of over-the-counter securities markets.  We find that such regulations promote entry of dealers, thus fostering competition and lowering spreads. Greater competition, however, has an indirect negative effect on market making profitability. General equilibrium effects imply that more competition can distort incentives of all dealers to invest in efficient technologies ex ante, and so can cause a social welfare loss. Our results are consistent with empirical findings on the effects of post-crisis regulations and with the opposition of some market participants to those regulations.


This paper updates the standard workhorse model of banks' reserve management to include frictions inherent to the market for federal funds. We apply the model to study monetary policy implementation through an operating regime involving voluntary reserve targeting. We argue that voluntary reserve targeting provides advantages relative to standard operating regimes. When reserves are abundant, as is the case following the unconventional policies adopted during the recent financial crisis, standard reserve requirements may lead to a collapse in interbank trade. We show that, no matter the relative abundance of reserves, voluntary reserve targets encourage market activity and support the central bank's control over interest rates. Various comparative statics are considered, including the impact of routine and non-routine liquidity injections by the central bank on market outcomes. We introduce non-depository institutions into the model and show that the central bank can control the federal funds rate without recourse to non-standard facilities such as reverse repos.


A dynamic model with credit under limited commitment is constructed, in which limited memory can weaken the effects of punishment for default. This creates an endogenous role for government debt in credit markets. Default can occur in equilibrium, and government debt essentially plays a role as collateral and thus improves borrowers' incentives. The optimal provision of government debt acts to discourage default, whether default occurs in equilibrium or not.


The events from the 2007-2009 financial crisis have raised concerns that the failure of large financial institutions can lead to destabilizing fire sales of assets. The risk of fire sales is related to exemptions from bankruptcy's automatic stay provision enjoyed by a number of financial contracts, such as repo. An automatic stay prohibits collection actions by creditors against a bankrupt debtor or his property. It prevents a creditor from liquidating collateral of a defaulting debtor since collateral is a lien on the debtor's property. In this paper, we construct a model of repo transactions, and consider the effects of changing the bankruptcy rule regarding the automatic stay on the activity in repo and real investment markets. We find that exempting repos from the automatic stay is beneficial for creditors who that hold the borrowers' collateral. Although the exemption may increase the size of the repo market by enhancing the liquidity of collateral, it can also lead to subsequent damaging fire sales that are associated with reductions in real investment activity. Hence, policy makers face a trade-off between the benefits of investment activity and the benefits of liquid markets for collateral.


Prior to 1863, state-chartered banks in the United States issued notes–dollar-denominated promises to pay specie to the bearer on demand. Although these notes circulated at par locally, they usually were quoted at a discount outside the local area. These discounts varied by both the location of the bank and the location where the discount was being quoted. Further, these discounts were asymmetric across locations, meaning that the discounts quoted in location A on the notes of banks in location B generally differed from the discounts quoted in location B on the notes of banks in location A. Also, discounts generally increased when banks suspended payments on their notes. In this paper we construct a random matching model to qualitatively match these facts about banknote discounts. To attempt to account for locational differences, the model has agents that come from two distinct locations. Each location also has bankers that can issue notes. Banknotes are accepted in exchange because banks are required to produce when a banknote is presented for redemption and their past actions are public information. Overall, the model delivers predictions consistent with the behavior of discounts.