Required Reserves as a Credit Policy Tool

Yasin Mimir, Enes Sunel and Temel Taskin

Working Papers from Research and Monetary Policy Department, Central Bank of the Republic of Turkey

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.

Keywords: Banking sector; time-varying reserve requirements; macroeconomic and financial shocks (search for similar items in EconPapers)
JEL-codes: E44 E51 G21 G28 (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (12)

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Related works:
Journal Article: Required reserves as a credit policy tool (2013)
Working Paper: Required reserves as a credit policy tool (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:tcb:wpaper:1224

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