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The Trade offs in Leaning Against the Wind

Author

Listed:
  • François Gourio

    (The Federal Reserve Bank of Chicago)

  • Anil K. Kashyap

    (University of Chicago
    Bank of England)

  • Jae W. Sim

    (The Board of Governors of the Federal Reserve System)

Abstract

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.

Suggested Citation

  • François Gourio & Anil K. Kashyap & Jae W. Sim, 2018. "The Trade offs in Leaning Against the Wind," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 66(1), pages 70-115, March.
  • Handle: RePEc:pal:imfecr:v:66:y:2018:i:1:d:10.1057_s41308-017-0043-3
    DOI: 10.1057/s41308-017-0043-3
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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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