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Leaning Against the Wind: The Role of Different Assumptions About the Costs

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  • Lars E.O. Svensson

Abstract

“Leaning against the wind” (LAW), that is, tighter monetary policy for financial-stability purposes, has costs in terms of a weaker economy with higher unemployment and lower inflation and possible benefits from a lower probability or magnitude of a (financial) crisis. A first obvious cost is a weaker economy if no crisis occurs. A second cost—less obvious, but higher—is a weaker economy if a crisis occurs. Taking the second cost into account, Svensson (2017) shows that for representative empirical benchmark estimates and reasonable assumptions the costs of LAW exceed the benefits by a substantial margin. Previous literature has disregarded the second cost, by assuming that the crisis loss level is independent of LAW. Some recent literature has effectively disregarded the second cost, making it to be of second order by assuming that the cost of a crisis (the crisis loss level less the non-crisis loss level) is independent of LAW. In these cases where the second cost is disregarded, for representative estimates a small but economically insignificant amount of LAW is optimal.

Suggested Citation

  • Lars E.O. Svensson, 2017. "Leaning Against the Wind: The Role of Different Assumptions About the Costs," NBER Working Papers 23745, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:23745 Note: ME
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    References listed on IDEAS

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    1. Andrea Ajello & Thomas Laubach & J. David Lopez-Salido & Taisuke Nakata, 2016. "Financial Stability and Optimal Interest-Rate Policy," Finance and Economics Discussion Series 2016-067, Board of Governors of the Federal Reserve System (U.S.).
    2. Gourio, Francois & Kashyap, Anil K. & Sim, Jae W., 2017. "The Tradeoffs in Leaning Against the Wind," Working Paper Series WP-2017-21, Federal Reserve Bank of Chicago.
    3. Òscar Jordà & Moritz Schularick & Alan M. Taylor, 2016. "The great mortgaging: housing finance, crises and business cycles," Economic Policy, CEPR;CES;MSH, vol. 31(85), pages 107-152.
    4. Andrew Filardo & Phurichai Rungcharoenkitkul, 2016. "A quantitative case for leaning against the wind," BIS Working Papers 594, Bank for International Settlements.
    5. Lars E.O. Svensson, 2016. "Cost-Benefit Analysis of Leaning Against the Wind," NBER Working Papers 21902, National Bureau of Economic Research, Inc.
    6. Lars E.O. Svensson, 2014. "Inflation Targeting and "Leaning against the Wind"," International Journal of Central Banking, International Journal of Central Banking, vol. 10(2), pages 103-114, June.
    7. repec:eee:moneco:v:90:y:2017:i:c:p:193-213 is not listed on IDEAS
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    1. repec:eee:moneco:v:90:y:2017:i:c:p:193-213 is not listed on IDEAS

    More about this item

    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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