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About the article
Published Online: 2013-06-20
Published in Print: 2013-01-01
See Gray (2011), Lim et al. (2011), Montoro (2011), Montoro and Moreno (2011), Glocker and Towbin (2012) for a discussion of country experiences.
Endogenously determined short-term nominal interest rates will also be more volatile compared to a Taylor rule setup.
We also conduct an analysis of a model economy with a zero required reserves policy. However, since the dynamics of this case strongly resemble those of the fixed RRR economy, we do not include it in the paper in order to save space.
Christensen, Meh, and Moran (2011) and Angelini, Neri, and Panetta (2012) follow a similar route when analyzing countercyclical capital requirements for macroprudential purposes.
For examples, see Benigno et al. (2010), Jeanne and Korinek (2010), Mendoza and Quadrini (2010), Benigno et al. (2011), Brunnermeier and Sannikov (2011) and Christensen, Meh, and Moran (2011), among others.
Gilchrist and Zakrajšek (2012) illustrate that monetary policy response to credit spreads, as a means to maintain financial stability, countervails the adverse impact of financial disruptions on macroeconomic variables.
This study analyzes the role of public intermediation of funds in times of financial repression.
Beau, Clerc, and Mojon (2012) provide a section in which the institutional frameworks adopted by the US, the UK, and the European Union are discussed in terms of the implementation of macroprudential policies. Arguably, the governance of macroprudential policies in Turkey is similar to that in the European Union in that the European Systemic Risk Board is independent from the European Central Bank (as the BRSA is independent from the CBRT in Turkey), but does not possess ultimate control over all macroprudential policy measures (the CBRT being in full charge of, for example, currency/maturity composition and the level of reserve requirements).
Increasing reserve requirements prior to this regime change was essential because by doing so, the CBRT rendered itself the net lender in the overnight market. This way, when it decides to carry out a traditional auction (instead of a quantity auction) in the overnight funding market, it could raise the average cost of central bank funding, way above the benchmark policy rate, which can be adjusted only once a month.
The Turkish banking system has been considerably conservative in complying with the regulations enacted by the BRSA since the aftermath of the domestic financial turmoil of 2001. Indeed, the actual risk weighted capital adequacy ratio of the Turkish banking system is currently around 16%, which is much higher than the regulatory minimum.
The introduction of a wide overnight interest corridor by the CBRT has illustrated that the effectiveness of reserve requirement hikes on increasing the cost of extending credit for banks is dampened, if the rate at which the central bank provides as much liquidity as the banking system demands is close to the policy rate. See BRSA (2011) for the details of the collective policy measures taken by the BRSA and the CBRT during the excessive capital inflows era and the developments thereafter.
This assumption is useful in making the agency problem that we introduce in Section 3.2 more realistic.
The zero real return earned from required reserves actually implies that the central bank is remunerating reserves with a nominal rate equal to the rate of inflation. This is indeed consistent with the experience of commercial banks in Turkey, since their local currency denominated reserves have been remunerated with a nominal return in line with the rate of inflation in the period 2002:1–2010:3. For the remuneration rates, see www.tcmb.gov.tr/yeni/bgm/dim/TLzorunlukarsilikfaizorani.html.
This assumption ensures that bankers never accumulate enough net worth to finance all their equity purchases of nonfinancial firms via internal funds so that they always have to borrow from households in the form of deposits.
Derivations of equations (11), (12) and (13) are available in the technical Appendix.
We model monetary policy in a simplistic manner in order to isolate the impact of required reserves policy described below. We also abstain from modeling disturbances to money growth because they produce implausible inflation dynamics in a cash-in-advance model of a flexible price environment.
Perfect insurance within family members of households ensures that the increase in real balances and reserves demand is lumped into Tt, which does not alter the optimality conditions of the utility maximization problem.
Loss function analysis in Section 5.4 uses second-order approximation of equilibrium conditions.
The legal target of the risk-weighted capital adequacy ratio set by the BRSA in Turkey is 8%, however, in practice, commercial banks in Turkey maintain 16% for this ratio.
This is the period in which the CBRT changed the RRR for macroprudential purposes.
We do not input the series of reserve requirement ratios into this empirical equation because the observed credit spreads and deposit rates would endogenously reflect the impact of reserves.
On bank capital shocks, see Hancock, Laing, and Wilcox (1995), Brunnermeier and Pedersen (2009), Cúrdia and Woodford (2010), Iacoviello (2010), Meh and Moran (2010), Mendoza and Quadrini (2010), and Mimir (2013).
Financial shocks cannot be studied in this experiment because when financial frictions are absent, banks become a veil and bank capital is not defined.
Notice that the fluctuations in these two cases are around different steady states because the long-run value of RRR is different across economies.
RRR is assumed to be positive but fixed in order not to obscure the variance decomposition analysis.
The dynamics of the economy with no reserves are available upon request.
Standard deviations of model variables are computed over sufficiently long simulations of the approximated decision rules. When simulations are sufficiently long, the moments of the simulated data converge to their theoretical counterparts.
It is straightforward to predict that the volatility of nominal interest rates (which are not set by a monetary policy authority, but rather are determined endogenously) increases in this case as well.
Indeed, stabilizing credit spreads in this way is analogous to stabilizing distortionary consumption taxes in the usual Ramsey framework.
Accordingly, equation (30) is modified to be
Indeed, responding to credit partly resembles responding to asset prices because credit is defined as the market value of capital claims issued by production firms that are traded at the asset price of capital.
Consistent with the variance decomposition results reported in Table 2, the volatility of inflation under time-invariant reserves policy economies is reduced sharply when there are no financial shocks.
Reinhart and Rogoff (2008) and Borio and Drehmann (2009) argue that excessive credit expansions help predict financial crises.
Recall that the steady state of all of these economies is identical.
The first best of this model economy is achieved when both monetary and financial frictions are removed.
Notice that the recalibrated values for ϕ vary in the range of [2.7, 4.13], whereas the benchmark value for this parameter is 3.28.
Investment is more volatile when φ is lower precisely because less of the adjustment to the adverse TFP shock comes through asset price changes.