## 1. List of Main Behavioral Parameters and Their Baseline Calibration ..................................14

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### I. Introduction and motivation
- Context:
  - Central banks in highly dollarized, tightly managed exchange rate economies often lack independent interest rate policy and rely on administrative/direct monetary tools (exchange rate management, reserve requirements, limits on bank lending/borrowing).
  - Model-based forecasting and policy analysis systems (FPAS) provide a consistent framework to anchor policy decisions and assess complex/distortionary effects of administrative tools as private agents adjust behavior.
- Purpose:
  - Provide a practical guide for establishing and using a model-based policy analysis framework where financial-sector issues are central and traditional policy tools are limited.
  - Design a general system to describe main channels of the economy, trace transmission of macro and financial shocks, and formalize policymaking with a toolkit to analyze implications of monetary policy measures.

### II. Target environment and policy concerns
- Characteristic features:
  - (i) a high degree of openness;
  - (ii) high levels of financial dollarization that limit traditional monetary policy transmission;
  - (iii) a dominant role for banks intermediating foreign/domestic financial flows (loans to households and corporates) while corporates can also borrow directly from abroad.
- Typical policymaker concerns:
  - persistent current account deficits and fast accumulation of private and banking sector indebtedness;
  - exposure of firms and households to currency mismatch and implications for financial stability;
  - exposure to sudden decline in availability of funds to the economy.
- When domestic interest rate channels are weak, policymakers rely on direct instruments; attempts to make banks internalize risks may induce substitution toward direct foreign borrowing by the private sector.

### III. Model overview and design
- Model class and key features:
  - Stylized DSGE model based on a sticky-price business cycle framework, extended with an explicit financial intermediation sector and a flexible combination of direct and indirect monetary policy tools.
  - Real side: three production sectors, households consuming tradable and nontradable goods, profit-maximizing firms producing domestic goods and exports.
- Financial sector — four building blocks:
  - (i) important role for financial intermediation;
  - (ii) costly banking activities with costs producing loans and deposits;
  - (iii) two imperfectly substitutable sources of intermediated funds for firms: domestic bank loans and funds borrowed directly from abroad;
  - (iv) full financial dollarization.
- Policy instruments available to monetary authority:
  - reserve requirements or other direct controls on domestic banks;
  - foreign exchange interventions to manage the nominal exchange rate;
  - controls to limit/regulate the volume (or growth) of bank loans.

### IV. Role and behavior of agents
- Households:
  - consume domestic goods, supply differentiated labor, derive utility from consumption and disutility from labor with habit formation parameter χ; subject to a liquidity constraint requiring deposits Ht,d proportional to consumption expenditures.
- Firms:
  - use imports, fixed stock of capital, and labor to produce domestic goods; face price stickiness (Rotemberg cost) and obtain funds from nonbank intermediaries that bundle bank loans and foreign funds.
  - must borrow an amount F_{t}^{d} proportional to working capital and hold low-interest deposits in proportion to required loans.
- Banks:
  - produce deposits D_t and loans L_t, hold reserves R_t, obtain refinancing from central bank B_t and rest of world F_t, maximize profits subject to balance sheet constraint.
  - incur real costs in producing loans and deposits; marginal costs depend on ratio L_t/D_t, generating endogenous lending and deposit spreads.
  - Required reserves r_{d,t} on deposits and r_{f,t} on foreign liabilities affect lending/deposit rates: (i) increase in r_{d,t} raises lending rate with deposit rate unchanged; (ii) increase in r_{f,t} raises both rates.
- Nonbank intermediaries:
  - combine bank loans and foreign funds via a CES technology; the rate charged to firms is approximately the weighted average of bank lending rate and foreign interest rate.
  - sources are imperfect substitutes; demand for each source is downward-sloping in its interest rate.
- Constraints and implications:
  - Households have no direct access to world financial market; deposits are only saving instrument and loans required to finance consumption—introduces lending-deposit spread and raises cost of current consumption.
  - Firms obtain funds via bundled intermediaries, increasing marginal production cost and affecting price–activity interactions.

### V. Policy instruments and central bank processes
- Nominal exchange rate process:
  - log s_t = (1 - ρ_s) log S + ρ_s log s_{t-1} + e_t^s
  - Innovation term e_t^s can be used to manipulate nominal exchange rate path and be a function of other macro indicators.
- Required reserve processes:
  - r_{d,t} = (1 - ρ_{rd}) r_d + ρ_{rd} r_{d,t-1} + e_{d,t}^{r}
  - r_{f,t} = (1 - ρ_{rf}) r_f + ρ_{rf} r_{f,t-1} + e_{f,t}^{r}
  - r_d and r_f are unconditional means (steady state); innovations can depend on state of economy.
- Credit volume restrictions:
  - L_t ≤ L̄ or (1 + φ^{(1)}) L_{t-1} ≤ L_t, where φ is growth rate set by central bank.
  - When binding, the shadow value increases marginal cost of lending and the bank lending rate.

### VI. Balance of payments and dollarization
- Aggregated balance of payments links change in net position with rest of world to current account (debt service + trade balance).
- Full dollarization: investment income depends on actual change in nominal exchange rate; trade balance is X_t - P_{M,t} M_t.
- Ex-post investment income rate paid abroad involves terms with S_{t-1}, i_{t-1}^*, F_{t-1}, X_t, M_t, P_{X,t}, P_{M,t}, ω, consistent with source expressions.

### VII. Solution method and implementation
- Solution steps:
  - derive first-order optimality conditions for agents;
  - impose market clearing and aggregate conditions;
  - find non-stochastic steady state (balanced growth path with shocks = 0);
  - compute Taylor’s first-order expansion of optimality conditions around steady state;
  - integrate expectations using Schur generalized decomposition to find state-space representation.
- Implementation note:
  - IRIS Toolbox (Matlab based) is used for solution and experiments.

### VIII. Main characteristics of policy transmission
- Required reserves affect marginal costs of lending and deposits, altering lending/deposit spreads and costs for households’ consumption and firms’ production.
- Firms’ access to direct foreign borrowing mitigates policy impact; higher elasticity of substitution between bank loans and direct foreign funds reduces monetary policy effectiveness.
- Credit volume controls raise shadow value of lending constraints, increasing bank lending rates and inducing substitution toward direct foreign funds, weakening effectiveness.
- Managed exchange rate regime shelters fully dollarized balance sheets from currency-mismatch risks; large nominal exchange rate movements materialize via balance of payments equation.
- Risk-premium-like shocks can be modeled as:
  - (i) shock to cost of foreign funds facing banks/non-bank borrowers;
  - (ii) shock to domestic bank lending rate;
  - (iii) shock to country’s net position.

### IX. Calibration: objectives, approach, and steady-state normalization
- Calibration objectives:
  - Use data for Croatia to explain how parameters determine multipliers and transmission channels and to provide realistic parameterization for simulations.
- Parameter groups:
  - (1) parameters determining non-stochastic steady state;
  - (2) parameters affecting short-run dynamics;
  - (3) parameters determining stochastic properties (second moments).
- Four basic steps to parameterize steady state:
  1. Determine growth, inflation, and interest rate characteristics (α, π*, i*).
  2. Calibrate financial block and balance of payments using those values.
  3. Determine real economy parameters.
  4. Set numeraires (world price level and central parity) and compute steady-state values.
- Steady-state normalizations:
  - Normalize productivity A_t, exports X_t, and nominal exchange rate central parity S to 1.
  - World price P_t^* allowed a unit root (nominal variables non-stationary); steady state is a balanced growth path.
  - Taylor’s first-order expansion around a point on balanced growth path valid; coefficients independent of point chosen.

### X. Main calibrated parameters (Table 1: List of Main Behavioral Parameters and Their Baseline Calibration)
- α: Steady state rate of growth of real economy = 1.04^(1/4) − 1
- π* : Steady state rate of inflation, world economy = 1.02^(1/4) − 1
- i* : Steady state nominal rate of interest, world economy = 1.04^(1/4) − 1
- β : Discount factor = 0.96^(1/4)
- r_d : Steady state required reserve ratio on deposits = 0.05
- r_f : Steady state required reserve ratio on foreign liabilities = 0
- θ_D : Fixed component in deposit spread = 2.5/400
- θ_L : Fixed component in lending spread = 1/400
- θ_LD : Banking cost function parameter = 100
- ν : Determines share of bank loans in bundle borrowed by firms = 0.30
- Eta : Long-run elasticity of labor supply = 0
- γ_M : Import share of gross production = 0.34
- ò : Elasticity of substitution in monopolistically competitive markets = 6
- χ : Habit in consumption = 0.85
- ξ_W : Wage adjustment costs = 1/0.05
- ξ_P : Price adjustment costs = 1/0.07
- ε : Elasticity of substitution between bank loans and foreign funds = 2

### XI. Behavioral-parameter set and calibration guidance (short-run dynamics)
- Seven behavioral parameters for realistic short-run dynamics:
  - habit parameter χ;
  - loan-demand elasticities hλ and nλ;
  - price stickiness parameters nξ and τξ;
  - elasticity of substitution between bank loans and direct foreign funds η;
  - bank cost function parameter LDθ.
- Typical guidance:
  - Habit χ typically between 0.70 and 0.90 for most countries.
  - Loan-constraint parameters (hλ and nλ) set according to average magnitude of loan cycles relative to consumption/output cycles.
  - Price stickiness parameters related to annualized inflation response via 1 / nξ and 1 / τξ multiplied by four.
  - LDθ controls elasticity of deposit and lending rates to L/D ratio; baseline low value consistent with literature.
  - η calibrated using impulse-response fit (e.g., episode of de facto credit growth controls in 2003).

### XII. Shock estimation and second moments
- Estimation approach for shock standard errors:
  - Run Kalman filter with same number of shocks as observables (initial condition deterministic);
  - Use estimated unobservables and historical shocks to compute sample standard errors for shock processes.

### XIII. Experiments: credit crunch shocks (design and main findings)
- Three financial intermediation shock types examined (each):
  - All involve a 10 percentage point increase in relevant interest rate in first period and are brought back to zero at autoregressive rate 0.80.
- Shock types:
  - Type 1 (“domestic lending shock”): shock to banks’ optimal lending rate setting; banks cut back loans below market equilibrium raising marginal cost of bank lending and lending rates.
  - Type 2 (“country risk premium shock”): shock to rate at which foreign funds are available to domestic intermediation sector; higher foreign risk premium or reduced availability raises banks’ costs.
  - Type 3 (“interbank shock”): shock to rate at which banks refinance from interbank market (including central bank liquidity shortage).
- Core transmission channels:
  - Intertemporal channel: higher lending rates reduce current consumption → lower aggregate demand, output, inflation.
  - Cost channel: quantitatively important in type 1 (increased lending-deposit spread → supply-side effects; prices and inflation rise while activity falls).
  - Income channel: present in type 2 (higher rollover costs → sharp deterioration in real consumption demand and net investment position).
- Comparative outcomes and magnitudes:
  - All three raise lending rates; Type 1 raises lending-deposit spread (deposit rate unchanged); Types 2 and 3 do not change spread (marginal funding rate rises).
  - Credit volumes fall in all simulations, ranging from approximately 5 to 10 percent.
  - Type 2 produces largest decline in output driven by sharp fall in consumption despite export rise.
  - Type 3 yields smaller decline in output relative to types 1 and 2 due to moderate consumption drop and export rise.
  - NFLs rise under country risk premium shock; NFLs fall under domestic lending and interbank shocks.
  - Recovery dynamics: as credit crunch fades after first year, activity and prices overshoot before stabilizing; oscillations last two to three years, most pronounced under foreign risk premium shock.

### XIV. Policy-induced credit crunch: price-based controls on bank credit
- Two policy measures examined:
  - Increase reserve requirement (RR) on domestic deposits by 10 percentage points in first period, autoregressive decay 0.95 (effect dies out in 4–5 years).
  - Increase RR on banks’ foreign borrowing by 10 percentage points with same persistence.
- Transmission distinctions:
  - RR on deposits: raises lending-deposit spread (deposit rates fall, lending rates initially unchanged) → cost channel dominates → production costs and prices up, output and consumption down.
  - RR on foreign borrowing: raises marginal cost of borrowing abroad → lending and deposit rates both rise by ≈ same amount → intertemporal channel dominates → output falls mainly via lower domestic demand; quantitatively larger responses than RR on deposits when circumvention prevented.
- Circumvention effects:
  - If firms can substitute toward direct foreign borrowing at unchanged cost, quantitative impacts are smaller; substitution mitigates decline in targeted aggregates (total credit and total foreign liabilities).
  - If RR enforced on firms’ direct borrowing as well, effective lending rate to real sector is higher and declines in employment, consumption, and output are larger.
- Policy implication:
  - Measures targeting bank credit can significantly affect real activity; effectiveness depends on instrument and private sector’s ability to substitute funding sources.

### XV. Credit growth controls (quantitative limits)
- Experiment setup:
  - Credit growth limit: banks required to extend credit at a rate 4 percentage points lower than in “normal” times for four consecutive quarters (controls maintained for one year and abandoned afterwards).
  - Controls enter bank optimization as a quantitative restriction generating a shadow value that affects lending rate; because restriction is on growth rate, current lending depends on expected future shadow values.
- Main transmissions and dynamics:
  - On impact: lending rate increases, lending-deposit spread goes up (deposit rates unaffected), bank foreign liabilities fall.
  - Consumption falls (intertemporal channel); firms partially replace bank credit with direct foreign borrowing but overall credit (domestic + abroad) declines.
  - Inflation falls (demand effect dominates cost effect); terms of trade improve and exports rise, partially offsetting demand decline.
  - After controls removed: sharp reversal with oscillations; credit recovers to steady state in about three years.
- Comparative impacts:
  - Effects similar qualitatively to RR on foreign borrowing: both raise marginal financing costs and lower activity, consumption, employment.
  - Magnitude subdued when corporates can substitute with direct foreign borrowing; circumvention reduces effectiveness on targeted macro aggregates.
- Policy implication:
  - Direct credit-growth limits can slow rapid bank credit growth but impose significant real-sector costs; substitution possibilities and expectations about duration materially affect outcomes.

### XVI. Policy implications, model purpose, and limitations
- Policy implications (selected):
  - Direct measures (reserve requirements, credit growth limits) can be effective but have significant real-sector costs: lower consumption, output, employment, and asset prices.
  - Reserve requirements on foreign borrowing have larger quantitative effects than reserve requirements on deposits because they affect both lending and deposit rates.
  - Effectiveness depends on circumvention possibilities (direct foreign borrowing) and elasticity of substitution between bank loans and foreign funds.
  - Policymakers should weigh net benefits of alternative measures given potential circumvention and differential impacts on targeted aggregates.
- Model purpose:
  - Stylized small open-economy DSGE with explicit financial sector for policy analysis in environments with high openness, financial dollarization, and managed exchange rate; useful for policy analysis, forecasting, and financial-stability stress testing.
- Limitations:
  - Not a full general equilibrium model linking borrower ability to service debt to cost of debt; limited treatment of asset-quality feedback on bank balance sheets.
  - Excludes financial accelerator mechanisms and precautionary capital build-up motivations.
  - Bank balance sheets simplified to exclude capital requirement dynamics; extensions under development include housing sector, endogenous bank capital, and endogenous default rates.

*Source: IMF Working Paper content unit titled "1. List of Main Behavioral Parameters and Their Baseline Calibration ..................................14" (from _wp09123).*

### 1. List of Main Behavioral Parameters and Their Baseline Calibration ..................................14

### 1. List of Main Behavioral Parameters and Their Baseline Calibration ..................................14

### I. Introduction and motivation
- Central banks in highly dollarized, tightly managed exchange rate economies often lack independent interest rate policy and thus rely on administrative/direct monetary tools to address macroprudential concerns (e.g., rapid credit growth, buildup of external debt).
- Model-based forecasting and policy analysis systems (FPAS) provide a consistent framework to anchor policy decisions; their role is especially important where direct instruments are used, even if underutilized outside inflation-targeting regimes (footnote 2).
- Policymakers require a reliable system to assess complex and potentially distortionary effects of administrative tools as private agents adjust behavior.
- Purpose of the paper:
  - Provide a practical guide for establishing and using a model-based policy analysis framework in economies where financial sector issues are central and traditional policy tools are limited.
  - Design a general system to describe main channels of the economy, understand transmission of macro and financial shocks, and formalize policymaking with a toolkit to analyze implications of monetary policy measures.

### II. Target environment and policy concerns
- Characteristic features of the environment:
  - (i) a high degree of openness;
  - (ii) high levels of financial dollarization that limit the scope for traditional monetary policy transmission;
  - (iii) a dominant role for banks to intermediate foreign or domestic financial flows in the form of loans to households and corporates, while corporates can also borrow directly from abroad.
- Typical policymaker concerns:
  - persistent current account deficits and fast accumulation of private and banking sector indebtedness;
  - exposure of non-financial firms and households to currency mismatch and implications for financial stability;
  - exposure to a sudden decline in the availability of funds to the economy.
- When traditional domestic interest rate channels are weak, policymakers rely on direct instruments (exchange rate management, regulatory requirements, limits on bank lending/borrowing). Efforts to make banks internalize risks may lead the private sector to substitute toward direct foreign borrowing.

### III. Model overview and design
- Model class and extensions:
  - Stylized dynamic stochastic general equilibrium (DSGE) model based on a standard sticky-price business cycle framework, extended to include an explicit financial intermediation sector and a flexible combination of direct and indirect monetary policy tools.
  - Real side: three production sectors, utility-maximizing households consuming tradable and nontradable goods, profit-maximizing firms producing domestic goods (sold domestically) and exports (sold abroad).
- Financial sector — four building blocks:
  - (i) an important role for financial intermediation (not just internal financing);
  - (ii) costly banking activities, with costs associated with producing loans and deposits;
  - (iii) two imperfectly substitutable sources of intermediated funds for firms: domestic bank loans and funds borrowed directly from abroad;
  - (iv) full financial dollarization.
- Policy instruments available to the monetary authority:
  - a variety of reserve requirements or other direct controls imposed on domestic banks;
  - foreign exchange interventions to manage the nominal exchange rate;
  - controls to limit/regulate the volume (or growth) of bank loans.

### IV. Role and behavior of agents
- Households:
  - consume domestic goods and supply differentiated labor;
  - derive utility from consumption and disutility from labor with habit formation parameter χ (consumption today affected by the past);
  - maximize expected discounted utility subject to a budget constraint and a liquidity constraint requiring deposits, Ht,d, proportional to consumption expenditures.
- Firms:
  - domestic firms use imports, a fixed stock of capital, and labor to produce domestic goods; they are monopolistically competitive and face price stickiness;
  - exports are an exogenous endowment; terms of trade are exogenous.
  - Firms use loans to cover expenditures and hold deposits in proportion to required loans; they obtain funds from nonbank intermediaries (a bundle of bank loans and foreign funds) to finance working capital.
- Banks:
  - collect deposits from households and firms, extend loans to households and nonbank intermediaries;
  - incur real costs in producing loans and deposits, resulting in upward sloping marginal costs in the loan-to-deposit ratio and endogenous lending and deposit spreads;
  - clear net surplus/deficit of funds with the world financial market;
  - deposits and foreign liabilities are subject to unremunerated reserve requirements set by the monetary authority.
- Nonbank intermediaries:
  - auxiliary agents (part of banks) that bundle bank loans and foreign funds into a composite fund supplied to firms with a constant elasticity of substitution;
  - when combining two imperfectly substitutable sources, they minimize total cost and the demand for each source is downward-sloping in its interest rate;
  - the rate charged to firms is effectively (up to first order) a weighted average of the bank lending rate and the foreign interest rate.
- Constraints and implications:
  - Households have no direct access to the world financial market; deposits are their only saving instrument and loans are required to finance consumption—this raises the cost of current consumption and introduces a lending-deposit spread.
  - Firms must obtain funds via the bundled intermediary, increasing marginal production cost and affecting price–activity interactions over the business cycle.

### V. Purpose of the model applications and shocks analyzed
- Use of the model:
  - analyze linkages between real and financial sectors and how policy measures and shocks affect key economic and financial aggregates;
  - capture issues observed in emerging Europe, including rapid bank lending growth and domestic credit crunches from global financial crisis spillovers.
- Shocks and policy experiments (as described in the paper organization):
  - externally induced credit crunch shocks;
  - policy-induced credit supply shocks (e.g., changes in direct monetary policy instruments);
  - price-based credit measures and direct credit controls are analyzed in later sections (see section headings and figures listing).

*Source: IMF Working Paper content unit titled "1. List of Main Behavioral Parameters and Their Baseline Calibration ..................................14"*

### 20.      Domestic producers produce differentiated goods and sell them in monopolistically

### _wp09123 - 20.      Domestic producers produce differentiated goods and sell them in monopolistically competitive market to households.

### Production, firms, and goods markets
- Domestic producers produce differentiated goods and sell them in monopolistically competitive markets to households.
- Individual prices and quantities are distinguished (lower-case letters and indices i) from market-wide prices and quantities (upper-case letters).
- Production function (as given):
  - q_{ti} = A_t * ( )^{...} (expression preserved in source)
  - Where q_{ti} is firm i’s output, A_t is the level of productivity (common to all producers in the sector), m_t and k_t are imports and capital used in production.

### Price adjustment and nominal rigidities
- Each producer faces Rotemberg’s (1982) quadratic costs of price adjustments with backward indexation.
- Costs of deviating from last period’s market-wide inflation act as a short-cut for costs associated with frequent price re-optimization and are the source of nominal rigidities.

### Firm liquidity constraint and working capital
- Each domestic firm must borrow an amount F_{t}^{d} proportional to its working capital and hold it as liquid assets (low-interest deposits).
- Liquidity constraint (formal expression preserved in source):
  - ,,,Ftt   tt   tMtt dWhZkPm ′ =++ 
  - Input factor prices: W_t, Z_t, and P_t refer to prices of labor, capital, and imports respectively.

### Banks: balance sheets, objectives, and costs
- Banks produce deposits D_t and loans L_t, hold reserves R_t with the central bank, get refinancing from the central bank B_t and the rest of the world F_t, and maximize profits (profit function preserved in source).
- Balance sheet constraint: L_t + R_t + D_t + B_t + F_t = (expression summarized as in source).
- Required reserves apply to both deposits and foreign liabilities:
  - r_{d,t} on deposits and r_{f,t} on foreign liabilities, set by the central bank.
- Interest rates:
  - L_t^i, D_t^i, B_t^i are interest rates on loans, deposits, and central bank refinancing respectively.
  - i_t^* is the interest rate on foreign funds.
  - [E_t S_{t+1}/S_t - 1] is the expected rate of depreciation (appears in bank profit function because loans, deposits, and foreign funds are denominated in foreign currency whereas reserves are held in domestic currency).
- Bank cost function h_t(L,D):
  - Marginal costs (w.r.t. both loans and deposits) are functions only of the ratio L_t/D_t.
  - Higher L_t/D_t → higher lending and deposit rates; lower L_t/D_t → lower rates.
  - Required reserve ratios r_{d,t} and r_{f,t} affect lending and deposit rates: (i) increase in r_{d,t} raises lending rate with deposit rate unchanged; (ii) increase in r_{f,t} raises both rates.

### Non-bank financial intermediaries and bundling
- Financial intermediaries use a CES technology to combine bank loans and funds borrowed directly from abroad, and lend the bundle to domestic firms.
- Loans, foreign funds, and the bundle are denominated in foreign currency.
- The rate charged to firms is approximately the weighted average of the bank lending rate and the foreign rate.
- Sources are not perfect substitutes; demand for each is interest cost elastic. Demand functions approximated up to first order (as in source).

### Central bank instruments and policies
- The central bank uses three types of instruments:
  1. Manages the nominal exchange rate and sets the two required reserve ratios.
     - Nominal exchange rate process:
       - log s_t = (1 - ρ_s) log S + ρ_s log s_{t-1} + e_t^s
       - Innovation term e_t^s is a tool to manipulate the nominal exchange rate path and can be a function of other macro indicators.
  2. Sets required reserve ratios r_{d,t} and r_{f,t} as autoregressive processes with potentially non-zero unconditional means:
     - r_{d,t} = (1 - ρ_{rd}) r_d + ρ_{rd} r_{d,t-1} + e_{d,t}^{r}
     - r_{f,t} = (1 - ρ_{rf}) r_f + ρ_{rf} r_{f,t-1} + e_{f,t}^{r}
     - r_d and r_f are unconditional means (steady state); innovation terms can be functions of the state of the economy.
  3. May impose temporary credit volume restrictions on banks via a maximum period-on-period growth rate in total loans:
     - L_t ≤ L̄ or (1 + φ^{(1)}) L_{t-1} ≤ L_t, where φ is the growth rate set by the central bank.
     - When credit controls are in place, one of the above constraints is assumed binding as an equality; the shadow value increases marginal cost of lending and the bank lending rate.

### Balance of payments and dollarization
- Aggregated balance of payments links change in net position with the rest of the world to the current account (debt service + trade balance).
- Full dollarization entails dependence of investment income on actual change in nominal exchange rate:
  - Expression (as given in source) includes terms with S_{t-1}, i_{t-1}^*, F_{t-1}, X_t, M_t, P_{X,t}, P_{M,t}, ω, and other indexed variables.
- Trade balance is X_t - P_{M,t} M_t (notation preserved as in source).
- The ex-post investment income rate paid abroad is (1 + i_{t-1}^*) (S_{t-1}/S_{t-1}).

### Solution method and model implementation
- Steps to solve the model:
  - Derive first-order optimality conditions for all agents.
  - Impose market clearing conditions and re-write aggregate conditions.
  - Find non-stochastic steady state (balanced growth path where shocks are deterministic zeros).
  - Calculate Taylor’s first-order expansion of optimality conditions around steady state.
  - Integrate future expectations using the Schur generalized decomposition and find state-space representation (as described in Klein (2000)).
- Implementation note: The IRIS Toolbox (a Matlab based package for economic modelling) is used for these steps and experiments.

### Main characteristics of policy transmission
- Model links real and financial sectors and can analyze impacts of domestic and external shocks, and policy measures (reserve requirements, credit limits) on the economy over a medium-term horizon.
- Transmission channels highlighted:
  - Required reserves affect marginal costs of lending and deposits, altering lending/deposit spreads and thus costs for households’ consumption and firms’ production. Firms’ access to direct foreign borrowing mitigates policy impact; higher elasticity of substitution between bank loans and direct foreign funds reduces monetary policy effectiveness.
  - Credit volume controls raise the shadow value of lending constraints, increasing bank lending rates and inducing substitution toward direct foreign funds, weakening effectiveness.
  - A managed exchange rate regime shelters fully dollarized balance sheets of firms and households from currency-mismatch risks because revenues and expenses are in domestic currency while deposits and loans are in foreign currency; large nominal exchange rate movements materialize via the aggregated balance of payments equation.
  - Risk-premium-like shocks can be modeled in at least three ways: (i) shock to cost of foreign funds facing banks and non-bank borrowers; (ii) shock to domestic bank lending rate; (iii) shock to country’s net position.

### Model calibration: objectives and approach
- Calibration uses data for Croatia to:
  - Explain how parameters determine main multipliers and transmission channels.
  - Provide a realistic parameterization for interpreting simulations and policy experiments.
- Parameters divided into three groups:
  1. Parameters determining non-stochastic steady state.
  2. Parameters affecting short-run dynamics but not necessarily steady state.
  3. Parameters determining only stochastic properties (second moments).

### Parameterizing steady state: steps and logic
- Four basic steps:
  1. Determine growth, inflation, and interest rate characteristics (α, π*, i*).
  2. Calibrate financial block and balance of payments using those values.
  3. Determine real economy parameters.
  4. Set numeraires (world price level and central parity) to arbitrary values and compute steady-state values for all model variables.
- Procedure details:
  - Given long-run domestic lending rate, use Euler equation to obtain discount factor β and adjusted discount factor β%.
  - Deposit rate linked to foreign rate through optimum lending rate equation.
  - Calibrate steady state required reserve ratios r_d and r_f, choose long-run ratio L_ss/D_ss and parameter θ_{LD}.
  - Infer θ_D and θ_L (fixed components of deposit and lending spreads) and check consistency with θ_{LD} for cost function restrictions.

### Financial block calibration inputs and steps
- Required inputs:
  - Desired steady state for net foreign liabilities (NFL) or trade surplus/deficit (TS).
  - Proportion in which non-bank intermediaries combine bank loans and direct foreign funds.
  - Ratio of bank loans to firms vs. households.
- Use balance of payments to link NFL and TS; check implied net investment income with observed data for consistency.
- Pin down share parameter ν consistent with assumed bank-loan-to-foreign-funds ratio, calculate implied interest rate on bundle i_b,t.
- Use balance sheet identities to determine ratios of all financial categories to GDP.

### Real economy steady-state calibration
- With financial ratios and net exports known, use real economy optimality conditions to calculate ratios of the two types of consumption, output, exports and imports to GDP, and parameters h_κ and n_κ (share of consumption and input bill financed through borrowing).
- Elasticity of substitution in monopolistic markets ε (or mark-up μ) used to fine-tune export/import share in domestic value added.
- γ (elasticity of real marginal costs to output) can be set to 1 without loss of generality.
- Over the business cycle, effect of output on marginal costs and inflation is controlled by parameter n_ξ.
- Given calibration of h_λ and n_λ (see source), related parameters are uniquely determined.

### Steady-state normalization and Taylor expansion
- Normalize productivity A_t, exports X_t, and nominal exchange rate central parity S to 1.
- World price P_t^* is allowed a unit root (nominal variables non-stationary); steady state is a balanced growth path.
- Taylor’s first-order expansion around a point on the balanced growth path is valid; coefficients are independent of the point chosen.
- Choosing a world price level determines import price and, via model identities, the steady-state values for all variables.

### Main calibrated parameters (Table 1: List of Main Behavioral Parameters and Their Baseline Calibration)
- α: Steady state rate of growth of real economy = 1.04^(1/4) − 1
- π* : Steady state rate of inflation, world economy = 1.02^(1/4) − 1
- i* : Steady state nominal rate of interest, world economy = 1.04^(1/4) − 1
- β : Discount factor = 0.96^(1/4)
- r_d : Steady state required reserve ratio on deposits = 0.05
- r_f : Steady state required reserve ratio on foreign liabilities = 0
- θ_D : Fixed component in deposit spread = 2.5/400
- θ_L : Fixed component in lending spread = 1/400
- θ_LD : Banking cost function parameter = 100
- ν : Determines share of bank loans in bundle borrowed by firms = 0.30
- Eta : Long-run elasticity of labor supply = 0
- γ_M : Import share of gross production = 0.34
- ò : Elasticity of substitution in monopolistically competitive markets = 6
- χ : Habit in consumption = 0.85
- ξ_W : Wage adjustment costs = 1/0.05
- ξ_P : Price adjustment costs = 1/0.07
- ε : Elasticity of substitution between bank loans and foreign funds = 2

### Additional calibration notes
- Balance of payments equation used to link NFL to TS; consistency of implied net investment income with observed data should be checked.
- Given assumptions on bank loans/foreign funds and nonbank intermediaries, the share parameter ν and implied bundle interest rate b_t^i are determined.
- With nominal expenditure ratios and numeraires set, steady states for individual variables are obtained; the world price choice determines import price and other steady-state values.

*Source: _wp09123 - 20.      Domestic producers produce differentiated goods and sell them in monopolistically competitive market to households.*

### 44.      There are seven behavioral parameters that have been introduced to help produce

### _wp09123 - 44.      There are seven behavioral parameters that have been introduced to help produce

### Behavioral-parameter set and calibration guidance
- Seven behavioral parameters introduced to produce realistic short-run dynamics:
  - habit parameter, χ
  - elasticity of loan demands to real consumption or real costs, hλ and nλ
  - price stickiness parameters, nξ and τξ
  - elasticity of substitution between bank loans and direct foreign funds, η
  - parameter of the bank cost function, LDθ
- Calibration objective: set these parameters with respect to system properties of the model as a whole (responses to external, policy, and domestic shocks; implied autocorrelations) while using general guidance for first-pass values where available.

### Habit parameter (χ)
- Role (three-fold):
  - reduces the short-run elasticity of substitution in consumption between tradables and domestic (unitary in the long run);
  - reduces the short-run elasticity of intertemporal substitution (sensitivity of consumption to the real interest rate);
  - entails dependence of consumption on its own lag.
- Typical realistic values for most countries: between 0.70 and 0.90.

### Loan-constraint parameters (hλ and nλ)
- Purpose: increase the elasticity of loans to consumption and of funds borrowed from intermediaries to production costs (both are unitary in the long run).
- From the two constraints, the elasticities are in both cases 1/ (1)λ−.
- These should be set according to the average magnitude of loan cycles relative to consumption cycles or output cycles.

### Price stickiness parameters (nξ and τξ)
- Guidance: the inverses, 1 / nξ and 1 / τξ, multiplied by four (to relate them to annualized inflation), compare well to stylized parameters on:
  - the output gap in models with a New Keynesian Phillips curve;
  - the pass-through of nominal exchange rate or world price shocks to domestic inflation (the parameter in tradables).

### Bank cost parameter (LDθ)
- Controls the elasticity of the deposit and lending rates to L/D ratio.
- Needs to satisfy general conditions for a well-behaved cost function.
- Baseline calibration value is kept low (literature standard for parameters serving to close the model).
- Also controls the responsiveness of the banking sector to the credit cycle and the business cycle; subject to calibration experiments.

### Elasticity between bank loans and foreign funds (η)
- Calibrated to achieve reasonable model properties in terms of impulse responses.
- Control experiment used: the episode of de facto credit growth controls in 2003 that saw a marked increase in direct foreign borrowing relative to domestic credit extended by banks.

### Additional parameters and estimation of shock standard errors
- Several other parameters describe reduced-form autoregressive processes for exogenous and policy variables; first-pass values usually obtained by running simple regressions.
- To describe second moments of the model-induced distributions, parameterize standard errors of the various shocks using this procedure:
  - Run a Kalman filter with the same number of shocks as observables (initial condition treated as deterministic numbers).
  - In that case, estimates of unobservables and historical shocks do not depend on the structure of relative standard errors; use these estimates to compute sample standard errors.

### Using the model-based framework for policy analysis — implications of a credit crunch
- Purpose: present policy-relevant experiments illustrating model use for central bank policymaking (transmission of important external and domestic shocks); emphasize impact of direct policy measures over the business cycle and of shocks affecting financial intermediaries and the real sector.
- Experiments relate to ongoing global financial market events.

### Relevance of analyzing negative credit supply shocks
- Since mid-2007 global financial turmoil evolved from advanced-economy crisis to a “sudden stop” in international funding.
- Initial wholesale financing cuts in advanced economies spilled over to emerging markets as higher refinancing costs, limited access to funding, and slowdown in economic activity.
- Speed and extent of spillovers driven by growing financial interlinkages between western economies and emerging markets, notably increased foreign ownership of banking systems in Europe.
- CESE countries are heavily exposed to Western European banks; some western European countries are exposed through operations concentrated in the region.11
- Growing financial links increase susceptibility to contagion and vulnerability to availability and cost of external funding under tighter global liquidity.

### Observed and expected credit-tightening effects
- Since mid-2007, tighter global market conditions indicated a credit crunch in the euro area: banks tightening credit standards.12
- Credit supply diminished due to:
  - higher funding costs for banks;
  - uncertainty about funding availability;
  - reassessment of risks;
  - banks managing size and composition of balance sheets.
- Effects on growth: moderation of credit supply raises cost of funding consumption and investment and reduces expectations for income and wealth growth.
- Emerging Europe: credit supply diminished as a result of reduced access to funds and/or higher funding costs from abroad, and banks’ increased risk aversion; real-economy effects expected to be greater because credit growth has been funded increasingly by foreign borrowing. Diagram 2 illustrates main transmission channels.13

### Experiments on credit crunch scenarios
- Explore negative credit supply shocks combining elements from Diagram 2:
  - (i) tighter lending by banks (e.g., increased risk aversion);
  - (ii) reduced or costly access to external funding by banks and corporations;
  - (iii) tighter liquidity raising the interbank borrowing rate for banks.
- Also analyze policy-induced credit crunch: effects of direct monetary policy tools aimed at reducing rapid bank-loan growth (e.g., price-based controls on bank lending and foreign borrowing or credit growth limits).
- Shock specification in simulations:
  - shocks assumed to last one year (temporary);
  - unexpected in the first period of the simulation, but expected thereafter.
- First-round channels through which shocks affect real activity:
  - (i) intertemporal channel;
  - (ii) cost channel;
  - (iii) income channel.

*Italicized source attribution line.*

### 59.      In this experiment, we examine the effects of the following financial intermediation

### _wp09123 - 59.      In this experiment, we examine the effects of the following financial intermediation

### Overview of experiment and shock types
- The experiment examines financial intermediation shocks that affect banks’ and the non-bank private sector’s ability to borrow from abroad and banks’ ability to lend.
- The shocks mimic difficulties observed in emerging market economies during the global financial crisis.
- Three shock types are modeled:
  - Type 1 (a “domestic lending shock”): shock to banks’ optimal lending rate setting; banks cut back loans below market equilibrium, raising the marginal cost of bank lending and lending rates.
  - Type 2 (a “country risk premium shock”): shock to the rate at which foreign funds are available to the domestic financial intermediation sector; higher foreign risk premium or reduced availability of foreign funds raises banks’ costs and elicits optimized responses in lending and deposit rates.
  - Type 3 (an “interbank shock”): shock to the rate at which banks can refinance from the interbank market (including central bank liquidity shortage).

### Shock specification and dynamics
- All three shocks:
  - Involve a 10 percentage point increase in the relevant interest rate in the first period.
  - Are gradually brought back to zero at an autoregressive rate of 0.80 (the autoregressive rate is set so that the effect of the shocks dies out in 2-3 years).
- Core transmission channels identified:
  - Intertemporal channel: Present in all three simulations; higher lending rates reduce current consumption, lowering aggregate demand, output, and inflation.
  - Cost channel: Quantitatively important only in type 1 (domestic lending shock) via increased lending-deposit spread; resembles a supply-side shock—prices and inflation rise while activity falls.
  - Income channel: Present only in type 2 (country risk premium shock); higher borrowing rates to roll over foreign debt sharply deteriorate real consumption demand and the net investment position.

### Comparative transmission and real-sector effects (summary from Table 2 and narrative)
- On impact:
  - All three shock types raise lending rates.
  - Type 1: lending-deposit spread goes up because deposit rate is unchanged (marginal rate of funding not affected).
  - Type 2 and Type 3: no change in lending-deposit spread because marginal rate of funding also goes up.
- Key steps and outcomes (by shock):
  - Type 1 (Domestic Lending Shock):
    - Step 1: Consumption falls (intertemporal smoothing). Cost of bank funding rises, shifting up output supply curve and pushing up domestic prices. Exports fall via deteriorated terms of trade.
    - Step 2: Output falls, demand for domestic credit and direct foreign borrowing fall, net foreign liabilities fall, inflation goes up.
    - Step 3: Demand for factor inputs, rental rate of capital, price of capital, wages, and employment fall; employment falls notably due to labor supply effects tied to higher lending-deposit spread.
    - Net effect: Output falls due to both lower consumption and lower exports; inflation may rise above long-run level during output downturn.
  - Type 2 (Country Risk Premium Shock):
    - Step 1: Consumption falls (intertemporal smoothing and income channel from higher rollover costs).
    - Step 2: Output falls, demand for domestic credit and direct foreign borrowing fall, net foreign liabilities increase (despite lower credit demand) because of higher refinancing costs, inflation falls, terms of trade improve, exports rise partially mitigating output fall.
    - Step 3: Rental rates and capital prices fall; nominal and real wages fall; employment fluctuates around original level as lower wages compensate output fall.
    - Net effect: Largest decline in output driven by sharp fall in consumption despite export rise.
  - Type 3 (Interbank Shock):
    - Step 1: Consumption falls (intertemporal smoothing).
    - Step 2: Output falls, demand for domestic credit and direct foreign borrowing fall, net foreign liabilities fall, inflation falls, terms of trade improve, exports rise partially mitigating output fall.
    - Step 3: Similar declines in factor returns and wages as type 2; employment fluctuates around original level.
    - Net effect: Smaller decline in output relative to types 1 and 2 due to moderate consumption drop and export rise.

### Financial-sector responses and magnitudes
- Credit volumes fall in all three simulations, ranging from approximately 5 to 10 percent.
- Credit supply curve (calibrated relatively flat) shifts upward in all simulations, making bank loans more expensive.
- Financial intermediaries partially substitute bank loans with direct borrowing except in type 2 where substitution is limited because both funding sources become more costly by the same amount.
- Demand for credit falls via:
  - Reduced real consumption (intertemporal and income channels),
  - Lower output and real exports (primarily via cost channel),
  - Movement in domestic prices translating real credit changes into nominal credit changes.
- Net foreign liabilities (NFLs) and current account:
  - NFLs rise (and current account deteriorates) under the country risk premium shock.
  - NFLs fall under domestic lending and interbank shocks.
- Recovery dynamics:
  - As the credit crunch fades after the first year, economic activity and prices overshoot before stabilizing at pre-shock levels, producing additional oscillations lasting two to three years.
  - Oscillations are most pronounced under the foreign risk premium shock due to limited corporate substitution and sharper production contraction.
  - Net foreign liabilities take longer to return to pre-shock levels partly because terms of trade and the risk premium adjust slowly.

### Policy-induced credit crunch: price-based controls on bank credit
- Two policy measures examined:
  - Increase in reserve requirement (RR) on domestic deposits.
  - Increase in RR on banks’ foreign borrowing.
- Consideration of circumvention: allowance for direct foreign borrowing by firms (normally outside monetary authority control) versus scenario where RR also enforced on firms’ direct borrowing.
- Policy shock specification:
  - RRs are raised by 10 percentage points in the first period.
  - Gradually brought back at an autoregressive rate of 0.95 (effect dies out in 4-5 years reflecting perceived permanence).
- Transmission distinctions:
  - Higher RR on deposits primarily affects the economy through the cost channel (supply-side): deposit rates fall, lending rates initially unchanged, lending-deposit spread rises, making liquidity costly and pushing up prices and lowering output via exports.
  - Higher RR on foreign borrowing primarily affects the economy through the intertemporal substitution channel: marginal cost of borrowing from abroad rises, lending and deposit rates increase by approximately the same amount, lending-deposit spread changes little, output falls mainly via lower domestic demand.
- Key modeled outcomes (from Table 3 and narrative):
  - RR on deposits:
    - On impact: deposit rates fall; lending rates unchanged.
    - Step 1–3: higher lending-deposit spread raises production costs and prices; net exports fall; output and consumption decline; employment declines proportionally more than output; net exports increase over time as terms of trade improve; output and credit recover gradually as inflation and spreads adjust.
    - Long run: falling output brings inflation down, substitution back to domestic goods, gradual recovery of output, consumption, and credit.
  - RR on foreign borrowing (no circumvention):
    - On impact: marginal cost of borrowing abroad rises; lending rate and deposit rate both rise by approximately same amount.
    - Step 1–3: higher lending rates reduce consumption; output falls driven by domestic demand; exports rise as domestic prices fall, partially mitigating output decline; bank credit and net foreign borrowing decline; wages and capital returns adjust downward over time.
    - Quantitatively larger responses in model variables compared with RR on deposits.
- Circumvention effects:
  - If firms can circumvent RRs on banks by direct foreign borrowing at unchanged cost:
    - Quantitative impact on model variables is smaller because private sector substitutes some bank credit with direct foreign borrowing (imperfect substitution).
    - Direct foreign borrowing by corporations increases under circumvention despite overall falling credit demand because relative cost from direct abroad borrowing is cheaper than domestic banking borrowing.
    - Net liabilities decline less because decreased banks’ foreign borrowing is offset by increased firms’ direct foreign borrowing.
  - If substitution is prevented (RR enforced on firms’ direct borrowing as well), the effective lending rate to the real sector is higher and declines in employment, consumption, and output are larger.
- Policy implication summary:
  - Measures targeting bank credit (RRs) can significantly affect real activity.
  - Effects depend on the instrument (RR on deposits vs RR on foreign borrowing) and private sector’s ability to substitute funding sources.
  - The targeted impact on macro aggregates (total credit to the private sector and total foreign liabilities) may be weaker than intended if circumvention and imperfect substitution occur.

*Source: _wp09123 - 59.      In this experiment, we examine the effects of the following financial intermediation*

### 73.      In this experiment, we examine the impact of imposing limits on the growth rates of

### The Simulated Effects of the Individual Policy Shocks to Credit Supply: Credit Growth Controls

### Experiment setup
- A quantitative restriction is imposed on the growth rate of credit extended by banks.
- The limits are maintained for the period of one year, and abandoned afterwards.
- Banks are required to extend credit at a rate 4 percentage points lower than in “normal” times for four consecutive quarters.
- The credit controls are introduced as a quantitative restriction to an individual bank’s optimization problem and give rise to a shadow value affecting the lending rate.
- Because the controls are imposed on the growth rate (not the level), today's lending-rate setting depends on today’s and tomorrow’s expected shadow value of the restriction.
- The information set-up (how long the controls are announced to last, how long they are expected, and how long they actually last) matters for outcomes.

### Main transmission channels (summary from Table 4 and Figure 3)
- Two principal channels: drop in consumption (intertemporal channel) and exports (more expensive production worsening competitiveness).
- On impact:
  - Credit to households and firms decline in line with the imposed credit growth controls.
  - The lending rate increases, reflecting the rise in the shadow value of the credit constraint.
  - The bank lending-deposit spread goes up, since deposit rates are not affected on impact (the marginal rate of foreign borrowing is unchanged).
  - Bank foreign liabilities fall, as the need for external borrowing to support credit growth declines.
- Step 1:
  - Consumption falls, following the rise in the lending rate.
  - Firms partially replace more expensive bank credit with cheaper direct foreign borrowing as the cost of bank credit goes up, but overall cost of credit to firms rises (and overall credit, both domestic and from abroad, decline).
  - Inflation falls, as the fall in demand (consumption) offsets higher production costs.
  - Terms of trade improve, as domestic prices fall.
- Step 2:
  - Exports increase as competitiveness (terms of trade) improve.
  - Output falls because of falling consumption.
  - Direct foreign borrowing also falls, as output falls, although less than bank credit. Overall, total foreign borrowing (by banks and firms) is lower because less credit extension by banks and lower output by firms require less borrowing from abroad.
- Step 3:
  - Real and nominal returns to capital decline; demand for capital declines, translating into falling real rental rate.
  - Price of capital (as an asset) declines following the decline in nominal rental rates and higher lending rates.
  - After a temporary drop, nominal wages rise to match higher inflation so that real wages are about unchanged.
  - Employment drops, as labor demand falls and the real wage rate does not adjust; the decline in labor is more pronounced given the higher price of labor relative to foreign inputs (nominal exchange rate unchanged).
- Step 4 (Long-run effects):
  - There is a sharp reversal after the growth controls are removed, with some oscillations before the economy reverts to its steady state.
  - Falling output brings inflation down; lower inflation subsequently improves terms of trade, exports, and output.
  - Interest rates adjust immediately after the controls are removed, and credit recovers, going back to its steady state after three years.

### Comparative impacts and substitution
- The impact of the credit limit on the real economy is similar qualitatively to those of the increase in reserve requirements on foreign borrowing: both raise the marginal cost of financing and lead to lower economic activity, consumption, and employment via higher bank lending rates.
- The magnitude of the shock is more subdued when the corporate sector can partially substitute bank credit with direct borrowing from abroad (circumvention of bank credit limits).
- When private agents can bypass measures by direct foreign borrowing, the quantitative impact on targeted macro aggregates (total credit to the private sector and total foreign liabilities of the economy) is smaller than intended.

### Key dynamics and timing
- The controls are anticipated by private agents; expectations about duration affect lending rates through expected future shadow values.
- After controls are removed:
  - Interest rates adjust immediately.
  - Credit to the private sector recovers back to its steady state, taking about three years to return fully.
  - The path includes oscillations in model variables during adjustment.

### Policy implications drawn in conclusions (selected)
- Direct measures to slow bank credit growth (credit limits, reserve requirements) can reduce rapid credit expansion but have significant real-sector costs: lower consumption, output, employment, and prices of factor inputs.
- Reserve requirements on foreign borrowing have larger quantitative effects than reserve requirements on deposits because they affect both lending and deposit rates; deposit reserve requirements affect only deposit rates on impact.
- The effectiveness of direct measures depends on transmission to the rest of the economy and the private sector’s ability to substitute with alternative funding sources (direct foreign borrowing).
- Policymakers should weigh net benefits of alternative measures given potential circumvention and differential impacts on targeted aggregates.

### Model purpose and limitations (selected)
- Purpose:
  - The model is a stylized small, open economy DSGE with an explicit financial sector designed for policy analysis in economies with high openness, financial dollarization, and a managed exchange rate.
  - It can be used for policy analysis, forecasting, and financial stability analysis (e.g., stress testing banking-sector resilience to shocks).
- Limitations:
  - Not a full general equilibrium model linking borrower ability to service debt to cost of debt; limited analysis of asset-quality feedback on bank balance sheets.
  - Excludes financial accelerator mechanisms and precautionary capital build-up motivations.
  - Channel capturing effects of deteriorating corporate balance sheets on borrowing costs is only approximate.
  - Bank balance sheets are simplified to exclude the need to hold capital, limiting analysis of changes in capital requirements.
- Extensions under development include:
  - (i) a housing sector with housing wealth and house prices generating a financial accelerator through households’ balance sheets;
  - (ii) endogenous bank capital with costly deviations from the optimum loan to capital ratio;
  - (iii) endogenous default rates of households vis-à-vis large unexpected depreciations and/or income drops.

*Source: IMF working paper section on credit growth controls and conclusions (excerpt).*

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