The effects of macroprudential policies on financial stability and macroeconomic indicators

Since the early 21st century, the increasing frequency of financial crises and their adverse effects on real economic activities have underscored the importance of expanding the fundamental assumptions (and models) of the prevailing paradigm to incorporate considerations of financial stability. This shift has also emphasized the adoption of macroprudential policy tools designed to promote macro-financial stability. In the case of Turkey, an emerging market economy, several instruments have been implemented since 2010 under the coordination of the Central Bank of the Republic of Turkey (CBRT) and the Financial Stability Committee to address vulnerabilities arising from volatility in capital flows, exchange rates, and credit growth. Macroprudential policies (MPPs), aimed at ensuring financial stability and enhancing the efficient allocation of resources to the real economy, are expected to complement monetary policy by improving the effectiveness of transmission channels and fostering macroeconomic stability. In this background, the objective of this study is to estimate the effects of macroprudential policies on capital flows, exchange rates, and credit growth through the estimation of a model incorporating key macro-financial variables relevant to Turkey's economic dynamics, while also examining how these policies influence output and price movements through these channels and assessing their transmission mechanisms. Additionally, the study calibrates a dynamic stochastic general equilibrium (DSGE) model, designed in closed-economy and partially open-economy frameworks, using Turkey-specific parameters to provide insights into the general equilibrium effects of MPPs. Empirical findings based on time series techniques indicate that MPPs have a negative effect on short-term capital inflows, exchange rate, credit growth and increase in prices, which are closely associated with financial instability. Furthermore, MPPs demonstrate the potential to limit macro-financial risks and volatilities while positively impacting output. The study also highlights significant spillover effects of MPPs on variables included in the model, with these effects intensifying dynamically during periods of heightened financial risks stemming from internal or external shocks in the Turkish economy. Moreover, the calibration results of the DSGE model for closed and partially open economies reveal that endogenous credit-debt ratios and countercyclical capital requirement shocks have substantial effects on macro-financial variables, including the banking sector's balance sheet, credit dynamics, and aggregate demand components. In light of the findings from this study, macroprudential policies adopted to mitigate the occurrence of financial crises in the long run have the potential to complement monetary policy by enhancing the effectiveness of the banking sector balance sheet, credit and exchange rate channels, thereby fostering a more robust financial-macroeconomic relationship and positively influencing the real economy.