Traditional and matter-of-fact financial frictions in a DSGE model for Brazil: the role of macroprudential instruments and monetary policy

Fabia Carvalho (), Marcos Castro and Silvio Costa

No 460, BIS Working Papers from Bank for International Settlements

Abstract: This paper investigates the transmission channel of macroprudential instruments in a closed economy DSGE model with a rich set of nancial frictions. Banks' decisions on risky retail loan concessions are based on borrowers' capacity to settle their debt with labor income. We also introduce frictions in banks' optimal choices of balance sheet composition to better reproduce banks'strategic reactions to changes in funding costs, in risk perception and in the regulatory environment.The model is able to reproduce not only price effects from macroprudential policies, but also quantity effects. The model is estimated with Brazilian data using Bayesian techniques. Unanticipated changes in reserve requirements have important quantitative effects, especially on banks' optimal asset allocation and on the choice of funding. This result holds true even for required reserves deposited at the central bank that are remunerated at the base rate. Changes in required core capital substantially impact the real economy and banks' balance sheet. When there is a lag between announcements and actual implementation of increased capital requirement ratios, agents immediately engage in anticipatory behavior. Banks immediately start to retain dividends so as to smooth the impact of higher required capital on their assets, more particularly on loans. The impact on the real economy also shifts to nearer horizons. Announcements that allow the new regulation on required capital to be anticipated also improve banks' risk positions, since banks achieve higher capital adequacy ratios right after the announcement and throughout the impact period. The effects of regulatory changes to risk weights on bank assets are not constrained to impact the segment whose risk was reassessed. We compare the model responses with those generated by models with collateral constraints traditionally used in the literature. The choice of collateral constraint is found to have important implications for the transmission mechanisms.

Keywords: DSGE models; Bayesian estimation; financial regulation; monetary policy; macroprudential policy (search for similar items in EconPapers)
Pages: 73 pages
Date: 2014-09
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-ger, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (23)

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Related works:
Working Paper: Traditional and Matter-of-fact Financial Frictions in a DSGE Model for Brazil: the role of macroprudential instruments and monetary policy (2013)
Working Paper: Traditional and matter-of-fact financial frictions in a DSGE model for Brazil: the role of macroprudential instruments and monetary policy (2013)
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