Title: Leaning against persistent financial cycles with occasional crises
Download PDF: Working Paper 56
This paper quantitatively investigates conditions under which a leaning against the wind (LAW)-type monetary policy is advisable to address risks to financial stability.
Authors: Thore Kockerols (ECB), Erling Motzfeldt Kravik (Norwegian Ministry of Finance), Yasin Mimir (ESM)
Abstract:
We study conditions under which a leaning against the wind (LAW)-type monetary policy is advisable to address risks to financial stability. We do so within a regime-switching dynamic stochastic general equilibrium (DSGE) model with endogenous crises and persistent financial cycles based on partly backward-looking house price beliefs. Under empirically plausible financial cycles, LAW increases inflation volatility because it amplifies the effects of supply shocks on inflation. It also leads to a lower average inflation, resulting in more frequent episodes of a binding lower bound on interest rates. LAW is advisable only if (i) the central bank puts more weight on output stability or (ii) financial cycles are less persistent than observed.
Disclaimer: This Working Paper should not be reported as representing the views of the ESM. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the ESM or ESM policy. No responsibility or liability is accepted by the ESM in relation to the accuracy or completeness of the information, including any data sets, presented in this Working Paper.
Keywords: leaning against the wind, monetary policy, financial cycle, regime-switching DSGE
JEL codes: E52, E58, G01