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Cost-Benefit Analysis of Leaning Against the Wind

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  • Svensson, Lars E O

Abstract

A simple and transparent framework for cost-benefit analysis of "leaning against the wind" (LAW), that is, tighter monetary policy for financial-stability purposes, is presented. LAW has obvious costs in the form of a weaker economy if no crisis occurs and possible benefits in the form of a lower probability and smaller magnitude of (financial) crises. A second cost - less obvious, overlooked by previous literature, but higher - is a weaker economy if a crisis occurs. For representative empirical benchmark estimates and reasonable assumptions the result is that the costs of LAW exceed the benefits by a substantial margin. The result is robust to alternative assumptions and estimates. A higher probability, larger magnitude, or longer duration of crises - typical consequences of ineffective macroprudential policy - all increase the margin of costs over benefits. To overturn the result, policy-interest-rate effects on the probability and magnitude of crises need to be more than 5-40 standard errors larger than the benchmark estimates.

Suggested Citation

  • Svensson, Lars E O, 2017. "Cost-Benefit Analysis of Leaning Against the Wind," CEPR Discussion Papers 11739, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11739
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    References listed on IDEAS

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    More about this item

    Keywords

    financial stability; macroprudential policy; monetary policy;

    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
    • G01 - Financial Economics - - General - - - Financial Crises

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