Essays in Macroeconomic and Macroprudential Policies

Abstract

In this dissertation, I focus on macroeconomic and macroprudential policies. In Chapter 1, I study the effectiveness of macroprudential policy tools on bank risk. The findings show that although macroprudential policy tools can stabilize the financial system, under certain conditions, they might have perverse effects. In Chapter 2, I examine monetary aggregates, and show that once measured correctly, they can be useful in gauging the stance of monetary policy. In Chapter 3, by studying the deter- minants of sovereign debt crises, I aim at improving our understanding of sovereign debt distress, and also strengthening the toolkit for crisis prevention. Chapter 1: Following the 2007-2009 financial crisis, there has been an increase in the use of macroprudential policy tools – such as loan-to-value ratio caps and interbank exposure limits – to achieve financial stability. Existing research on the effectiveness of macroprudential policy has focused on country-level variables such as total credit growth and house price inflation. In “The Effectiveness of Macropruden- tial Policy on Bank Risk,” I study how the effectiveness of macroprudential policy varies across banks and policy tools. Using system GMM on bank-level data from 30 European countries for the time period between 2000 and 2014, I document that stricter regulation in the form of exposure limitations tends to decrease banks’ risk levels whereas capital-based tools tend to induce higher risk-taking. After a policy tightening, loan loss provisions and non-performing loans ratios of banks suffering losses can increase substantially, up to five percentage points, while they are likely to decrease for profitable banks. Constraining activities by stricter regulation can lead to a search for yield. Therefore, policy designers should pay particular attention to the increase in risk-taking following policy tightening, especially by banks suffering losses. Chapter 2: It is crucial for policymakers to successfully gauge the stance of mon- etary policy and understand the mechanisms through which it affects the economy. Conventional models focus on interest rates alone, and omit monetary aggregates from policy discussions. In “Do Monetary Aggregates Belong in a Monetary Model? Evidence from the UK,” I examine whether augmenting the measure of monetary policy with monetary aggregates helps in drawing more robust links between policy and economic fluctuations. After constructing the Divisia money index for the United Kingdom, I employ structural vector autoregression to identify two different episodes of UK monetary policy regimes. Inclusion of this (correct) measure of the quantity of money and disentangling money supply from money demand remedy the price and liquidity puzzles which frequently appear in the vector autoregression literature. The results point to the informational content embedded in monetary aggregates, and suggest that monetary aggregates should be taken into account while evaluating monetary policy. Chapter 3: In assessing debt sustainability for advanced and emerging markets, the IMF’s Market Access Countries’ Debt Sustainability Analysis (MAC DSA) com- pares the levels of debt and gross financing needs (GFNs) against benchmarks sepa- rately derived from the noise-to-signal approach. In “Determinants of Sovereign Debt Crises,” I identify the main factors that contribute to sovereign debt crises. I take into account a broad range of debt distress drivers, including debt levels and gross fi- nancing needs, but also debt composition, macroeconomic fundamentals, and country characteristics such as whether the country is a small state or member of a currency union. By using the estimation results, I first derive an indicative cutoff probability of debt distress level. Then, I calculate the corresponding thresholds for debt variables, above which countries are predicted to experience an episode of debt distress.