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Should monetary policy lean against the wind? An analysis based on a DSGE model with banking

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  • Leonardo Gambacorta

    ()
    (Bank for International Settlements)

  • Federico M. Signoretti

    ()
    (Bank of Italy)

Abstract

The global financial crisis has reaffirmed the importance of financial factors for macroeconomic fluctuations. Recent work has shown how the conventional pre-crisis prescription that monetary policy should pay no attention to financial variables over and above their effects on inflation may no longer be valid in models that consider frictions in financial intermediation (Cúrdia and Woodford, 2009). This paper analyzes whether Taylor rules augmented with asset prices and credit can improve upon a standard rule in terms of macroeconomic stabilization in a DSGE with both a firms' balance-sheet channel and a bank-lending channel and in which the spread between lending and policy rates endogenously depends on banks' leverage. The main result is that, even in a model in which financial stability does not represent a distinctive policy objective, leaning-against-the-wind policies are desirable in the case of supply-side shocks whenever the central bank is concerned with output stabilization, while both strict inflation targeting and a standard rule are less effective. The gains are amplified if the economy is characterized by high private sector indebtedness.

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Bibliographic Info

Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 921.

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Date of creation: Jul 2013
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Handle: RePEc:bdi:wptemi:td_921_13

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Keywords: DSGE; monetary policy; asset prices; credit channel; Taylor rule; leaning-against-the-wind;

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As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Taylor rules with assets and credit
    by Economic Logician in Economic Logic on 2013-09-17 14:51:00
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Cited by:
  1. Thorsten Beck & Andrea Colciago & Damjan Pfajfar, 2014. "The role of financial intermediaries in monetary policy transmission," DNB Working Papers 420, Netherlands Central Bank, Research Department.

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