I document the cyclical properties of aggregate balance sheet variables of the U.S. commercial banking sector: (i) Bank credit and deposits are less volatile than output, while net worth and leverage ratio are several times more volatile, (ii) bank credit and net worth are procyclical, while deposits, leverage ratio and loan spread are countercyclical. I then present an equilibrium real business cycle model with a financial sector to investigate how the dynamics of macroeconomic aggregates and balance sheet variables of U.S. banks are influenced by empirically-disciplined shocks to bank net worth. I find that these financial shocks are important not only for explaining the dynamics of financial flows but also for the dynamics of standard macroeconomic variables observed in the U.S. data. The simulation of the model shows that the recent deterioration in aggregate net worth of U.S. banking sector contributed significantly to the 2007-09 recession. The model-construct tightness measure of credit conditions tracks quite well the FED Board's index of credit tightening in the last three recessions of the U.S economy implying that the Lagrange multipliers attached to the financial constraints in dynamic stochastic general equilibrium models with credit frictions might contain valuable real-time information about the financial conditions of an economy.

This paper conducts a quantitative investigation of the role of reserve requirements as a macroprudential 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 countervails 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) a 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.

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