Journal of Economic Modeling Research

---

The aim of this study is to theoretically investigate the role of the bank deposit market structure in how effective micro and macro prudential policies in determining the regulatory capital of banks in combination with monetary policy. To achieve this, a partial equilibrium analytical framework has been developed that includes rational economic entities and the possibility of contagion risk in the banking system in order to achieve more explicit and tangible results. In general, it will be shown that the imperfect structure of the bank deposit market as a policy transmission channel (which is less considered in the literature) can significantly change the micro and macro implications of such policies. Specifically, the effects of these policies on allocation and stabilization efficiency will be followed in terms of the types of conceivable equilibria for deposit rates, expected net returns, expected markup, and the level of expected effort of banks operating in the banking system. Expected markup capital elasticity of banking system smaller than one at the micro and macro levels play a special role in prudential policies. Each bank interactively with other banks would shape its solutions and expectations towards upcoming states of the economy (in so doing customizing its balance sheet asset side) along with key determinants for its solvency in respecting its financial obligations to depositors and whereby touching depositors’ confidence in its performance so hard that seizing utmost share in deposit market by bidding appropriate deposit rate. The deposit rate together with the level of monitoring efforts would further hit banking sector contagion risk drawing in its associated externalities and under well-defined conditions could expose the banking system to higher fragility.

---

Abstract: In the labor market literature, Shimer's criticism of the standard search and matching models indicates a low elasticity of the labor market as to the technology shock. As a result, the standard search and matching model is not able to explain the fluctuations observed in the main variables of the labor market, such as unemployment and job vacancies. In other words, in the standard model of search and matching with Nash bargaining, the fraction of fundamental surplus is large. Various explanations have been proposed to increase the elasticity of labor market compression to changes in productivity, and they all entail reducing the fundamental surplus fraction. By integrating the current and expected monetary policy induced debt overhang friction in the production and financial intermediatory sectors with a standard search and matching model this study aims at analyzing and pursuing how inclusion of this friction, through reducing the fundamental surplus and raising elasticity of labor market compression, could explain the excessive volatility in unemployment and job vacancy opportunities and thereby rendering a new solution for the Shimer’s puzzle. Further, the basic idea of this research was developed within a dynamic stochastic general equilibrium model including the key components of the search and matching model entailing the fundamental surplus fraction.  The resulting integrated model can be viewed as a theoretical framework for investigating the implications of including long-term risky nominal debt and the debt overhang for the fundamental surplus fraction in the structure involving financial frictions and the main features of the search and matching model subject to firm-specific productivity shocks and inflation. Considering the Iranian economy features, the model has been simutated for two cases one involves inertia in prices and the other one entails flexible prices.  The findings show that a monetary regime that leads to inflation would ensue the debt overhang episodes via reducing the real value of companies' debts. As leverage and default rates upsurge, firms pass up new investments and this leads to reduced labor force recruitment, job vacancy opportunities cut, and increased unemployment. As such, the debt overhang in companies lowers the fundamental surplus fraction and thus aggravates the impact of shocks on the elasticity of the labor market compression.