Required reserves as a credit policy tool
AbstractThis 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 InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 39613.
Date of creation: 22 Jun 2012
Date of revision:
Banking sector; time-varying reserve requirements; macroeconomic and financial shocks;
Other versions of this item:
- E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-07-01 (All new papers)
- NEP-BAN-2012-07-01 (Banking)
- NEP-CBA-2012-07-01 (Central Banking)
- NEP-DGE-2012-07-01 (Dynamic General Equilibrium)
- NEP-MAC-2012-07-01 (Macroeconomics)
- NEP-MON-2012-07-01 (Monetary Economics)
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