Presenting a model of how the central bank policies affect macroeconomic variables: A dynamic stochastic general equilibrium approach

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KAKAVANDI MOHAMMAD MAHDI; RAHBAR FARHAD; MEHRARA MOHSEN; SAREM MEHDI

Title

Presenting a model of how the central bank policies affect macroeconomic variables: A dynamic stochastic general equilibrium approach

Author(s)

KAKAVANDI MOHAMMAD MAHDI | RAHBAR FARHAD | MEHRARA MOHSEN | SAREM MEHDI | Issue Writer Certificate

Keywords

Credit shock

Finance

Banking

Monetary policy

Dynamic stochastic general equilibrium model

Abstract

Introduction: Banks, as the center of financial and payment systems, play a pivotal role in providing the resources needed for economic sectors by attracting and allocating resources in the economy. Therefore, the efficiency of the Banking sector is considered as a key factor in economic growth. In addition, due to the Banking-centric nature of the financing system in Iran, banks provide a significant part of the need for financial resources of manufacturing companies. So, shocks in financial markets affect the performance of firms by affecting the resources available to firms and, consequently, their financial expenditures, thereby affecting the real sector of the economy. The performance of banks is, in turn, influenced by the macroeconomic environment and the decisions of the central bank as a Monetary policy maker. Therefore, it is very important to study the effects of the central bank policies and the change in the behavior of banks as financial intermediaries on different sectors of the economy. The purpose of this article is to investigate the effect of central bank policies on macroeconomic variables with an emphasis on the behavior of banks as the main suppliers of capital and liquidity for the manufacturing sector. Methodology: In this article, the economic conditions of Iran are simulated in a Dynamic stochastic general equilibrium model using seasonal information from 1989 to 2018, and the effects of monetary, credit and real shocks on the country's economy are analyzed. The model used for this purpose covers four parts including production sector, household sector, bank sector and central bank and government sector. At the beginning of the period, the household is the supplier of labor and keeps its resources either as a deposit with the bank or as cash. The production sector consists of three parts including the entrepreneur, the producer of capital goods and the producer of the final goods (firm). The entrepreneur is the supplier of capital, and the producer of capital uses the capital purchased from the entrepreneur and his own capital to generate new capital and, again at the end of the period, to sell the new produced capital to the entrepreneur. In this model, banks use household deposits to provide facilities to enterprises; this loan is used to produce goods. So, the bank's major task is to provide working capital for the production units and the resources required by the entrepreneur at the interest rates which are determined in advance. According to the macroeconomic conditions of Iran, these interest rates are determined by the Monetary and Credit Council in an orderly manner and target the tools of the central bank. An important point about the assumptions of this model is that, unlike most similar studies, the entrepreneur who receives the credits from banks may go bankrupt and be unable to repay the received money. This assumption is taken into account in the model, as observed in Iran’ s economy. In this study, in order to design the model, the research works of Bernanke et al. (1999), Smith et al. (2007) and Boys and Zhou (2016) have been used. Results and Discussion: Based on the results obtained from the model, the occurrence of a negative Credit shock will reduce production, consumption and investment. It can also increase the interest rate on credits, raise the inflation and reduce working hours. Moreover, in case of contractionary monetary policies, production, consumption, investment, the number of working hours of the labor force and inflation can decrease while the interest on credits increases. The remarkable result about the implementation of contractionary monetary policies is that, after the implementation of this policy, the amount of credits granted by banks experiences fluctuations; it decreases at first, then increases again over a period of time, and then the effects of the shock gradually disappear. Conclusion: According to the results of the model, a contractionary policy in the form of reducing the amount of credits not only has a negative effect on production and consumption but also increases inflation. In other words, reduction of the level of aggregate demand as a result of a reduction in credits does not lead to the control of inflation. This is due to the high dependence of Iran's economy on bank credit financing. Therefore, it is suggested that the central bank not control macroeconomic variables by controlling banks' interest rates and loans, because it will not have desirable results. Instead, it is recommended that the central bank direct macroeconomic variables by controlling the policy rate in the interbank market and changing the volume of bank reserves.

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APA: Copy

KAKAVANDI, MOHAMMAD MAHDI, RAHBAR, FARHAD, MEHRARA, MOHSEN, & SAREM, MEHDI. (2021). Presenting a model of how the central bank policies affect macroeconomic variables: A dynamic stochastic general equilibrium approach. BIQUARTERLY JOURNAL OF ECONOMIC RESEARCH, 13(25 ), 109-142. SID. https://sid.ir/paper/957743/en

Vancouver: Copy

KAKAVANDI MOHAMMAD MAHDI, RAHBAR FARHAD, MEHRARA MOHSEN, SAREM MEHDI. Presenting a model of how the central bank policies affect macroeconomic variables: A dynamic stochastic general equilibrium approach. BIQUARTERLY JOURNAL OF ECONOMIC RESEARCH[Internet]. 2021;13(25 ):109-142. Available from: https://sid.ir/paper/957743/en

IEEE: Copy

MOHAMMAD MAHDI KAKAVANDI, FARHAD RAHBAR, MOHSEN MEHRARA, and MEHDI SAREM, “Presenting a model of how the central bank policies affect macroeconomic variables: A dynamic stochastic general equilibrium approach,” BIQUARTERLY JOURNAL OF ECONOMIC RESEARCH, vol. 13, no. 25 , pp. 109–142, 2021, [Online]. Available: https://sid.ir/paper/957743/en

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Scientific Information Database

ISSN: 2588-4824

Journal Paper

Presenting a model of how the central bank policies affect macroeconomic variables: A dynamic stochastic general equilibrium approach