Investigating the effects of monetary shocks on the key variables of Iran's economy in the conditions of the banking crisis Stochastic dynamic general equilibrium model approach

Document Type : Research Paper

Authors

1 Professor of the Faculty of Economics, University of Tehran, Tehran, Iran.

2 Associate Professor, Faculty of Economics, University of Tehran, Tehran, Iran.

3 PhD student of the Faculty of Economics, University of Tehran, Tehran, Iran.

Abstract

Purpose: Pricing The banking system plays an important role in the structure of an economy, and the challenges of this sector can affect other sectors. One of the most important challenges of the banking system is the occurrence of a banking crisis. The International Monetary Fund defines a banking crisis as a situation in which bank runs and bank failures spread and banks are unable to pay their debts, or a situation in which the government intervenes in the banking system on a large scale. In the conditions of banking crisis, bank bankruptcies are widespread and banks are unable to pay their debts. The occurrence of this type of crisis has various causes, the main reasons of which are the high volume of non-current claims and the freezing of bank assets as a result of corporate governance, which reduces the quality of bank assets to pay the bank's obligations, thus creating an imbalance in the banks' balance sheets. One of the features of a banking crisis is systemic risk. An increase in the systemic risk in the banking system coincides with the occurrence of a banking crisis.
Systemic risk can be defined as a risk that affects the financial sector and creates an endogenous cycle that exacerbates the effect of the initial shock and causes more damage to the financial sector. With the increase of systemic risk, the probability of crisis and financial and monetary instability increases and negatively affects the real sector of the economy. In normal times, when there is no crisis, banks help the rapid development of the economy and increase the standards of living, but, when a crisis occurs, the problems in the banking sector and the subsequent failures cause serious negative consequences not only in the banking sector but also in companies directly.  It also affects investors; the occurrence of banking crises during the last few decades has always caused problems for the countries engaged in the crisis. Among these problems, one may mention the financial costs of the crisis, production losses, increase in public debts, and increase in uncollectible loans. The banking industry in Iran is one of the important financial intermediaries that can provide the basis for the growth and prosperity of the economy by properly organizing resources and expenses. More than 80% of the financing in Iran is done through banks. Therefore, the health of this sector can significantly contribute to the improvement of economic conditions. The conditions of the Iranian economy and especially the banking system in recent years indicate the signs of a banking crisis in the Iranian economy; the money market pressure index, as one of the most important indicators for measuring the banking crisis, has faced more fluctuations since the end of the 80s. Considering the high share of the banking system in the financing of economic activities in Iran and the lack of studies in the field of banking crisis and its effects on macroeconomic variables, the present research investigates the effects of systemic risk, as a representative variable of banking crisis, on the selected macroeconomic variables.
Methodology: In order to analyze the effects of the banking crisis on macroeconomic variables, the stochastic dynamic general equilibrium model has been used in the form of two limit scenarios referring to a no-crisis situation and the presence of a banking crisis at the highest level using the data of Iran's economy during the years 1982-2020. In this study, a stochastic dynamic general equilibrium model for a small open economy in terms of oil exports has been developed with an emphasis on Iran's economy in the framework of the new Keynesian school, in which the effect of monetary impulse on macroeconomic variables in the framework of the banking crisis is investigated. As a key feature of the model, employment and production decisions by firms and labor supply and consumption decisions by households are made before goods are produced and exchanged and before market-clearing prices are realized. In the sector of companies producing intermediate inputs, all the company's resources are assumed to be provided by facilities, and the presence of crisis increases the cost of receiving facilities. It is also assumed that the existence of the crisis will limit the lending resources of commercial banks, which will increase the price of the received loans due to the lack of resources.
Results and discussion: The results show that, due to monetary stimuli, variables such as production and inflation show a positive reaction to the stimuli, but, over time, the effects disappear. As a result of inflation, the real wage has decreased, and the level of real consumption has also decreased due to the decrease in the purchasing power of the members of the society. Also, due to the inflation and the increase of investment cost, the amount of investment has also decreased. Therefore, the results are compatible with consumption and investment theories. Another important result regarding the systemic risk constraint in modeling is that the banking crisis has reduced the impact of monetary impulses on macroeconomic variables and reduced the size and extent of the impact.
Conclusions and policy implications: According to the results of the study, the existence of a banking crisis causes friction in the structure of the economy and the performance of the banking network, which affects various impulses and policies. Therefore, it is suggested that the central bank or the government should consider the state of the banking system from the perspective of its health in determining the rule and before implementing economic decisions.

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References

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The Journal of Economic Policy
Volume 15, Issue 30
March 2024
Pages 1-37

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