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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
  • Federico M Signoretti

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 for International Settlements in its series BIS Working Papers with number 418.

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Length: 45 pages
Date of creation: Jul 2013
Date of revision:
Handle: RePEc:bis:biswps:418

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

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References

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  1. Paolo Gelain & Kevin J. Lansing & Caterina Mendicino, 2012. "House prices, credit growth, and excess volatility: Implications for monetary and macroprudential policy," Working Paper 2012/08, Norges Bank.
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  7. Vasco Cúrdia & Michael Woodford, 2009. "Credit Spreads and Monetary Policy," NBER Working Papers 15289, National Bureau of Economic Research, Inc.
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  1. Taylor rules with assets and credit
    by Economic Logician in Economic Logic on 2013-09-17 14:51:00

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