REQUIREDRESERVESASACREDIT POLICYTOOLI Banking 7−→Gertler and Karadi (2011), Mimir (2011). I...

REQUIRED RESERVES AS A CREDIT

POLICY TOOL

(joint with Enes Sunel and Temel Taskın)

Yasin MimirCentral Bank of the Republic of Turkey

Conference on Reserve Requirements and Other MacroprudentialPolicies: Experiences in Emerging Economies

October 8, 2012

INTRODUCTION

Macroprudential Policies and Financial Stability

I Required reserves ratios (RRR) have been used as a macroprudentialpolicy tool in a number of emerging economies (e.g. Brazil, China,Colombia, Peru, and Turkey).

I In particular, they use reserve requirements to curb excessive creditgrowth in boom episodes and to ease financial constraints in badtimes.

I The main aim is to reduce the procyclicality of financial sector.

Motivating Questions

I How does a time-varying macroprudential RRR policy affectI Real and financial cycles of an economy in response to adverse

macroeconomic and financial shocks.I Welfare implications of moderate and aggressive RRR policies.

I Effectiveness of required reserves policy in different economicstructures (ex. highly leveraged financial system).

Building Blocks

I Quantitative monetary DSGE model with banksI Households face cash-in-advance (CIA) constraints.I Agency problem between households and banks via G&K (2011).I Banks are subject to time-varying RRR that countercyclically

responds to expected credit growth.I Simulate the model economy in the face of productivity and financial

shocks under two different RRR policy regimes: time-varying andfixed.

I Investigate the effectiveness of time-varying RRR policies throughimpulse response analysis.

I Compute welfare gains of alternative time-varying RRR policiescompared to fixed RRR policy.

Main Results

I Time-varying RRR rule countervails the negative effects of F.A.mechanism triggered by adverse macroeconomic and financialshocks.

I Counter-cyclical RRR rule reduces volatilities of key real andfinancial variables in response to macro shocks.

I Time-varying RRR policy reduces the intertemporal distortionscreated by the credit spread at the expense of higher inflationvolatility.

I Welfare gain of adopting time-varying RRR policies rather than fixedRRR one ranges from 0.06% to 0.22% in CE welfare terms.

I The effect of time-varying required reserves policy is bigger in highrisk economy where loan-deposit spread is higher and the leverage ofthe banking sector is lower.

Related Literature

I Banking 7−→ Gertler and Karadi (2011), Mimir (2011).

I Required reserves 7−→ Glocker and Towbin (2011), Montoro (2011).

I Countercyclical time-varying macro-prudential policy 7−→Christensen et al. (2011).

I ContributionI Explore the role of RRR policy in response to financial shocks.I Focus on the composition of the assets side of the balance sheet

rather than size of the balance sheet.

THE MODEL

FrameworkI Households Household’s Problem

I Workers supply labor, ht and return their wage incomes, wtht to H.H.I Households face cash-in-advance (CIA) constraints.I Each banker manages an intermediary and transfers earnings back.I H.H. owns intermediaries that its bankers manage.

I Financial Intermediaries Bank’s Problem

I Collect deposits, bt+1 from households (HH), combine it with theirown net worth, nt and purchase firms’ shares, qtst .

I Agency problem between HH and banks, leading to endogenouscapital constraints for banks in obtaining funds from HH.

I Banks are subject to time-varying RRR, rrt , that counter-cyclicallyresponds to expected credit growth.

I Non-financial Firms Firm’s Problem

I finance capital acquisition, Kt+1 each period via issuing equities, stand selling them to banks at the price of capital, qt .

I Capital Producers Capital Producer’s Problem Competitive Equilibrium

I buy depreciated capital from firms to repair and to build new capital.I sell new and repaired capital at price qt .

I

Government

I Money supply is assumed to grow at a constant rate µ

M0t+1 = exp(µ)M0t

I Required reserves ratio follows a time-varying rule in response todeviations of expected future credit growth.

rrt = rr + φEt

[log(qt+1st+1)− log(qtst)

]

where φ > 0 ⇒ relax financial markets when credit is shrinking

I The money market equilibrium necessitates

M0t+1 = Mt+1 + Ptrrtbt+1

I Increases in the monetary base are rebated to households throughlump-sum transfers

Tt = M0t+1 −M0t

Shock Process

I Productivity shocks

zt+1 = ρzzt + εzt+1 εzt+1 ∼ N(0, σz)

QUANTITATIVE ANALYSIS

Model Parameterization and Calibration

Description Value Target

Preferences

Quarterly discount factor (β) 0.9885 Annualized real deposit rate (4.73%)CRRA parameter in the utility (γ) 2 LiteraturePower parameter of labor (ν) 2 Frisch Elasticity of Labor Supply (0.5)Scale parameter for disutility of labor (ψ) 15.2 Hours worked (0.3348)

Production Technology

Share of capital in output (α) 0.40 Capital elasticity of outputCapital adjustment cost parameter (ϕ) 2.75 Relative volatility of investment ≈ 2.25Depreciation rate of capital (δ) 0.037 Long-run value of i/K

Government

Steady-state value of RRR (rr ) 0.05 Pre macro-prudential policy periodAdjustment parameter in the RRR rule (φ) 5.15 Std. Dev. of diff. in RRR for 2009:Q4 - 2012:Q2 (1.73%)

Financial Intermediaries

Fraction of diverted loans (λ) 0.5 Annual commercial & industrial loan spread (1.96%)Proportional transfer to the entering bankers (ε) 0.001 2.63% of aggregate net worthSurvival probability of the bankers (θ) 0.962 Capital adequacy of 16% for commercial banks

Shock Processes

Persistence of TFP process (ρz) 0.9821 Estimated from detrended logTFPt = ρz logTFPt−1 + εztStd. deviation of productivity shocks (σz ) 0.0183

F.A. Effects (TFP Shocks)

Adverse TFP Shocks

0 20 40−2

−1.5

−1

−0.5Output

%∆

from

S.S

.

Credit Policy Fixed RR Ratio

0 20 40−4

−3

−2

−1

0

1Investment

0 20 400

0.5

1

1.5

2

2.5Hours

0 20 40−0.8

−0.6

−0.4

−0.2

0

0.2Price of Equity

0 20 40−6

−4

−2

0

2Net Worth

%∆

from

S.S

.

0 20 40−2

0

2

4Leverage

0 20 40−2

−1.5

−1

−0.5

0Bank Credit

0 20 40−100

0

100

200

300Loan−Deposit Spread

Ann

ualiz

ed B

s. P

t. ∆

from

S.S

.

0 20 40−1.5

−1

−0.5

0

0.5Required Reserves Ratio

% P

t. ∆

from

S.S

.

Quarters0 20 40

0

5

10

15Velocity

%∆

from

S.S

.

Quarters0 20 40

−1

−0.5

0

0.5

1

1.5Inflation

Quarters0 20 40

−25

−20

−15

−10

−5

0Reserves

Quarters

Adverse Financial Shocks

0 20 40−2

−1.5

−1

−0.5

0

0.5Output

%∆

from

S.S

.

Credit Policy Fixed RR Ratio

0 20 40−6

−4

−2

0Investment

0 20 40−3

−2

−1

0

1Hours

0 20 40−1

−0.5

0

0.5Price of Equity

0 20 40−15

−10

−5

0Net Worth

%∆

from

S.S

.

0 20 400

2

4

6

8

10Leverage

0 20 40−1.5

−1

−0.5

0Bank Credit

0 20 400

100

200

300

400


Ann

ualiz

ed B

s. P

t. ∆

from

S.S

.

0 20 40−0.8

−0.6

−0.4

−0.2

0

0.2Required Reserves Ratio

% P

t. ∆

from

S.S

.

Quarters0 20 40

−8

−6

−4

−2

0

2Velocity

%∆

from

S.S

.

Quarters0 20 40

−1

−0.5

0

0.5

1Inflation

Quarters0 20 40

−15

−10

−5

0

5Reserves

Quarters

Effect of Credit Policy on Volatilities

φ = 0* φ = 5.925* φ = 1 φ = 10

(κ = 6.25)

(Rk − R = 48 bs. pt.)Variable Fixed Reserves Credit Policy Credit Policy Credit PolicyReal VariablesOutput 2.77 1.66 2.22 1.50Consumption 1.21 1.09 1.21 1.06Investment 7.76 3.83 5.49 3.40Hours 2.79 2.36 2.50 2.42

Financial VariablesCredit 1.24 0.72 0.91 0.66Deposits 1.53 1.57 1.10 2.07Net Worth 12.30 6.42 6.25 6.46Leverage 11.38 6.30 6.00 6.38Credit Spread 0.45 0.26 0.33 0.25Asset Prices 0.80 0.39 0.57 0.35

Monetary VariablesInflation 0.19 0.27 0.18 0.34

Sensitivity: High Risk vs. Low Risk Economies

λ = 0.25 λ = 0.25 λ = 0.75 λ = 0.75

(κ = 12.51) (κ = 4.17)

(Rk − R = 27 bs. pt.) (Rk − R = 69 bs. pt.)Variable Fixed Reserves Credit Policy Fixed Reserves Credit PolicyReal Variables

Output 2.37 1.59 3.25 1.73Consumption 1.23 1.13 1.22 1.07Investment 5.63 3.30 10.01 4.37Hours 1.48 2.29 3.99 2.41


Monetary VariablesInflation 0.10 0.27 0.27 0.27

Sensitivity: Financial Accelerator

ϕ = 0.275 ϕ = 0.275 ϕ = 13.75 ϕ = 13.75

(κ = 6.25)

(Rk − R = 48 bs. pt.)Fixed Reserves Credit Policy Fixed Reserves Credit Policy

Real Variables

Output 2.86 1.94 2.53 1.27Consumption 1.13 1.06 1.57 1.19Investment 8.48 5.02 5.69 1.97Hours 2.90 2.16 2.49 2.58


Monetary Variables

Inflation 0.20 0.23 0.16 0.34

Welfare Evaluation

Vtrp0 = E0

∞∑

t=0

βtU(c trpt , l trpt ) Vfrp0 = E0

∞∑

t=0

βtU(c frpt , l frpt )

Vtrp0 = E0

∞∑

t=0

βtU((1 + λc)c frpt , l frpt

)

I λc : proportional increase of regime frp’s consumption plan that ahousehold must demand to be as well off as under policy regime trp.

I Moderate time-varying RRR policy (φ = 5) => λc = 0.06%.

I Aggressive time-varying RRR policy (φ = 10) => λc = 0.22%.

Conclusion

I RRR policies that are meant to stabilize credit growth work as amacro-prudential tool under the existence of TFP and financialshocks.

I However, reduced volatilities of real and financial variables come atthe expense of higher inflation volatility.

I For further work, small open economy features and optimal monetarypolicy considerations shall be introduced in order to reconcile theanalysis more with the experience of emerging economies.

THANK YOU

CHAPTER 2: THE MODEL

Workers

maxct ,lt ,bt+1,Mt+1

E0

∞∑

t=0

βtu(ct , lt)

s.t. ct + bt+1 +Mt+1

Pt

= wt(1− lt) + Rtbt +Mt

Pt

+Πt

Pt

+Tt

Pt

and ct ≤Mt

Pt

+Tt

Pt

+ Rtbt − bt+1

⇒ uc(t) = βEt

{Rt+1uc(t + 1)

}

ul(t)

Ptwt

= βEt

{uc(t + 1)

Pt+1

}

Back

BankersI Banker j collects deposits from worker i 6= j , lend to a large number

of identical firms, and hold required “reserves”

qtsjt = (1− rrt)bjt+1 + njt

II Net worth accumulation into the next period,

njt+1 = Rkt+1qtsjt − Rt+1bjt+1 + rrtbjt+1 ⇒

njt+1 =

[Rkt+1 −

(Rt+1 − rrt

1− rrt

)]qtsjt +

(Rt+1 − rrt

1− rrt

)njt

ESPt+1 RRt+1

I Required reserves make net worth financing more preferable

dESPt+1

drrt< 0 and

dRRt+1

drrt> 0

I Banks operate only if Et

{β1+iΛt,t+1+iESPt+1+i

}≥ 0 ∀i

Back

Bankers cont’d

I Bankers maximize the terminal value of their net worth

Vjt = maxsjt

Et

∞∑

i=0

(1− θ)θiβ1+iΛt,t+1+injt+1+i

I s.t. an agency problem: After borrowing from households, bankerscan divert λ fraction of their total assets.

I Incentive compatibility:Vjt ≥ λqtsjt

Bankers cont’d

I Vjt can be written as follows:

Vjt = νtqtsjt + ηtnjt ≥ λqtsjt

I When it binds:qtsjt =

ηtλ− νt

njt = κtnjt

I Financial intermediaries may fund non-financial firms only up to an“endogenous multiple” of their net worth

I We aggregate over j and get: qtst = κtnt

Firms

I Finance capital acquisition each period via issuing equity claimswhich are purchased by financial intermediaries

qtst = qtKt+1

I Produce with a CRS technology by using capital and labor

exp(zt)F (Kt ,Ht)

I Labor demand satisfies

wt = exp(zt)FH(Kt ,Ht)

I Zero profit condition leads to following condition of return oncapital:

Rkt =exp(zt)FK (Kt ,Ht) + qt(1 − δ)

qt−1

Back

Capital Producers

I Buy depreciated capital from firms, repair it, and build new capital

II Sell new and repaired capital at the asset price qt

II Profit maximization

maxIt

Πcp = qtKt+1 − qt(1− δ)Kt − It

s.t. Kt+1 = (1− δ)Kt +Φ

(It

Kt

)Kt

I “Q” relation for investment

qt =

[Φ

′

(It

Kt

)]−1

Back

Competitive EquilibriumI Nominal monetary base and prices grow constantly in this model,

which renders the equations listed above non-stationary. Therefore,following Cooley and Hansen (1989), we make the model stationary

by applying the following normalizations: Pt = Pt/M0t+1 and

mt = Mt+1/(PtM0t+1) and solve the model locally around adeterministic steady state.

I A competitive equilibrium of this model economy is defined bysequences of allocations {ct , kt+1, it , lt , ht , st , nt , net , nnt , bt+1,Λt,t+1, νt , ηt , κt , ρt,t+1, χt,t+1, mt+1, πt}

∞

t=0, prices

{qt ,Rkt+1,Rt+1,wt , Pt}∞

t=0, shock processes {zt}∞

t=0 and thegovernment policy {rrt}

∞

t=0 such that

(i) allocations solve household’s, financial intermediary’s, firm’s, andcapital producer’s problems at the equilibrium prices.

(ii) markets for factor inputs clear.

(iii) aggregate resource constraint is satisfied.Back

Financial Accelerator (TFP ↓)

0 10 20 30 40−1.8

−1.6

−1.4

−1.2

−1Output

% ∆

from

S.S

.

FADSGE

0 10 20 30 40−4

−3.5

−3

−2.5

−2

−1.5Investment

0 10 20 30 40−0.4

−0.3

−0.2

−0.1

0

0.1Price of Equity

% ∆

from

S.S

.

Quarters0 10 20 30 40

−50

0

50

100

150

200


Ann

ualiz

ed B

s. P

t. ∆

from

S.S

.

Quarters

Back

REQUIREDRESERVESASACREDIT POLICYTOOLI Banking 7−→Gertler and Karadi (2011), Mimir (2011). I...

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