Exchange Rate Volatility, Financial Imbalances and Optimal Monetary Policy

The objective of this study is designing an optimal monetary policy rule in order to react to firms’ debt accumulation and stabilizing the economy. To address this, a DSGE model is designed where the effects of exchange rate oscillation, firms’ debt, and financial instability on the economy are investigated. The derived optimal monetary policy rule from this model shows that when the level of accumulated debt is high, the nominal interest rate (or the policy rule) should be increased. This can lead to financial stability through controlling over outstanding accumulated debt.