Essays on Financial Intermediaries, Business Cycles and Macroprudential Policies

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This study conducts a quantitative analysis of the role of financial shocks and credit frictions affecting the banking sector in driving business cycles as well as the role of reserve requirements as a macroprudential policy tool. In the first chapter, I first empirically document three stylized business cycle facts of aggregate financial variables in the U.S. commercial banking sector for the period 1987-2010: (i) Bank credit, deposits and loan spread are less volatile than output, while net worth and leverage ratio are more volatile, (ii) bank credit and net worth are procyclical, while deposits, leverage ratio and loan spread are countercyclical, and (iii) financial variables lead the output fluctuations by one to three quarters. I then present an equilibrium business cycle model with a financial sector, featuring a moral hazard problem between banks and its depositors, which leads to endogenous capital constraints for banks in obtaining funds from households. Credit frictions in banking sector are modeled as in Gertler and Karadi (2011). The model incorporates empirically-disciplined shocks to bank net worth (i.e. "financial shocks") that alter the ability of banks to borrow and to extend credit to non-financial businesses. The model is calibrated to U.S. data from 1987 to 2010. I show that the benchmark model driven by both standard productivity and financial shocks is able to deliver most of the stylized facts about real and financial variables simultaneously. Financial shocks and credit frictions in banking sector are important not only for explaining the dynamics of aggregate financial variables but also for the dynamics of standard macroeconomic variables. Financial shocks play a major role in driving real fluctuations due to their strong impact on the tightness of bank capital constraint and credit spread, which eventually affect the saving-investment nexus of the economy. Finally, the tightness of bank capital constraint given by the Lagrange multiplier in the theoretical model (which determines the banks' ability to extend credit to non-financial firms) tracks the index of tightening credit standards (which shows the adverse changes in banks' lending) constructed by the Federal Reserve Board quite well.

The second chapter (coauthored with Enes Sunel and Temel Taskin) undertakes a quantitative investigation of the role of reserve requirements as a credit 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 mitigates 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) an operational 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.