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Required reserves as a credit policy tool

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  • Mimir, Yasin
  • Sunel, Enes
  • Taskin, Temel

Abstract

This paper conducts a quantitative investigation of the role of reserve requirements as a macroprudential policy tool. We build a monetary DSGE model with a banking sector in which (i) an agency problem between households and banks leads to endogenous capital constraints for banks in obtaining funds from households, (ii) banks are subject to time-varying reserve requirements that countercyclically respond to expected credit growth, (iii) households face cash-in-advance constraints, requiring them to hold real balances, and (iv) standard productivity and money growth shocks are two sources of aggregate uncertainty. We calibrate the model to the Turkish economy which is representative of using reserve requirements as a macroprudential policy tool recently. We also consider the impact of financial shocks that affect the net worth of financial intermediaries. We find that (i) the time-varying required reserve ratio rule countervails the negative effects of the financial accelerator mechanism triggered by adverse macroeconomic and financial shocks, (ii) in response to TFP and money growth shocks, countercyclical reserves policy reduces the volatilities of key real macroeconomic and financial variables compared to fixed reserves policy over the business cycle, and (iii) a time-varying reserve requirement policy is welfare superior to a fixed reserve requirement policy. The credit policy is most effective when the economy is hit by a financial shock. Time-varying required reserves policy reduces the intertemporal distortions created by the credit spreads at expense of generating higher inflation volatility, indicating an interesting trade-off between price stability and financial stability.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 39613.

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Date of creation: 22 Jun 2012
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Handle: RePEc:pra:mprapa:39613

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Keywords: Banking sector; time-varying reserve requirements; macroeconomic and financial shocks;

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References

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  1. Glocker, C. & Towbin, P., 2012. "Reserve Requirements for Price and Financial Stability - When Are They Effective?," Working papers 363, Banque de France.
  2. Vasco Cúrdia & Michael Woodford, 2009. "Credit spreads and monetary policy," Staff Reports 385, Federal Reserve Bank of New York.
  3. Mimir, Yasin, 2012. "Financial intermediaries, credit Shocks and business cycles," MPRA Paper 39648, University Library of Munich, Germany.
  4. Carlos Montoro & Ramon Moreno, 2011. "The use of reserve requirements as a policy instrument in Latin America," BIS Quarterly Review, Bank for International Settlements, March.
  5. Bengt Holmstrom & Jean Tirole, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," Working papers 95-1, Massachusetts Institute of Technology (MIT), Department of Economics.
  6. Lasse Heje Pederson & Markus K Brunnermeier, 2007. "Market Liquidity and Funding Liquidity," FMG Discussion Papers dp580, Financial Markets Group.
  7. Kevin Moran & Cesaire A. Meh & Ian Christensen, 2010. "Bank Leverage Regulation and Macroeconomic Dynamics," 2010 Meeting Papers 757, Society for Economic Dynamics.
  8. Césaire Meh & Kevin Moran, 2008. "The Role of Bank Capital in the Propagation of Shocks," Working Papers 08-36, Bank of Canada.
  9. Cooley, T.F. & Hansen, G.D., 1988. "The Inflation Tax In A Real Business Cycle Model," RCER Working Papers 155, University of Rochester - Center for Economic Research (RCER).
  10. Frank Smets & Raf Wouters, 2007. "Shocks and Frictions in US Business Cycles : a Bayesian DSGE Approach," Working Paper Research 109, National Bank of Belgium.
  11. Reinhart, Carmen & Reinhart, Vincent, 1999. "On the use of reserve requirements in dealing with capital flow problems," MPRA Paper 13703, University Library of Munich, Germany.
  12. Jaromír Beneš & Kirdan Lees, 2010. "Multi-period fixed-rate loans, housing and monetary policy in small open economies," Reserve Bank of New Zealand Discussion Paper Series DP2010/03, Reserve Bank of New Zealand.
  13. Hancock, Diana & Laing, Andrew J. & Wilcox, James A., 1995. "Bank capital shocks: Dynamic effects on securities, loans, and capital," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 661-677, June.
  14. Enes Sunel, 2013. "Distributional and Welfare Consequences of Disinflation in Emerging Economies," Working Papers 1334, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
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Cited by:
  1. Matthew Greenwood-Nimmo & Artur Tarassow, 2013. "A Macroeconometric Assessment of Minsky’s Financial Instability Hypothesis," Macroeconomics and Finance Series 201306, Hamburg University, Department Wirtschaft und Politik.
  2. Bin Wang & Tao Sun, 2013. "How Effective are Macroprudential Policies in China?," IMF Working Papers 13/75, International Monetary Fund.
  3. Adrián Armas & Paul Castillo & Marco Vega, 2014. "Inflation Targeting and Quantitative Tightening: Effects of Reserve Requirements in Peru," IDB Publications 84714, Inter-American Development Bank.
  4. Arif Oduncu & Yasin Akcelik & Ergun Ermisoglu, 2013. "Reserve Options Mechanism:A New Macroprudential Tool to Limit the Adverse Effects of Capital Flow Volatility on Exchange Rates," Central Bank Review, Research and Monetary Policy Department, Central Bank of the Republic of Turkey, vol. 13(3), pages 45-60.

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