Exogenous shocks, contagion, and bank soundness: a macroeconomic framework

Abstract

In a model where all banks are initially solvent, an exogenous shock affects confidence, causing a flight from deposits into domestic and foreign currency. Real interest rates increase unexpectedly, affecting firms and raising the share of the banks nonperforming assets. This contagion causes a bank run. Simulations show that compensatory monetary policy mitigates the bank run but causes macroeconomic imbalances. Combining compensatory monetary policy with tight fiscal policies slows the bank run and mitigates insolvency. A devaluation, combined with compensatory monetary policy, reduces insolvencies and increases the growth of real income, but at the cost of increased inflation.