The Trade offs in Leaning Against the Wind

Credit booms sometimes lead to financial crises and subsequent severe and persistent economic slumps. So should monetary policy “lean against the wind” and counteract excess credit growth, or should it focus only on inflation and output stability? We study this issue quantitatively in a small New Ke...

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Bibliographic Details
Published in:IMF economic review 2018-04, Vol.66 (1), p.70-115
Main Authors: Gourio, François, Kashyap, Anil K., Sim, Jae W.
Format: Article
Language:English
Subjects:
Analysis
Capital Markets
Credit policy
Economic crisis
Economic growth
Economic models
Economic Policy
Economics
Economics and Finance
Inflation
International Economics
Keynesian theory
Macroeconomics/Monetary Economics//Financial Economics
Monetary policy
RESEARCH ARTICLE
Risk
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Summary:Credit booms sometimes lead to financial crises and subsequent severe and persistent economic slumps. So should monetary policy “lean against the wind” and counteract excess credit growth, or should it focus only on inflation and output stability? We study this issue quantitatively in a small New Keynesian dynamic stochastic general equilibrium model in which the risk of financial crises depends on “excess credit.” We compare monetary policy rules responding to the output gap to rules that respond to excess credit. We find that responding to credit can lead to a lower average probability of financial crisis, at the cost of higher cyclical volatility in inflation and output. We discuss the factors that affect the desirability of leaning against the wind.
ISSN:2041-4161
2041-417X
DOI:10.1057/s41308-017-0043-3