A quantitative case for leaning against the wind
Andrew Filardo () and
Phurichai Rungcharoenkitkul
No 594, BIS Working Papers from Bank for International Settlements
Abstract:
Should a monetary authority lean against the build-up of financial imbalances? We study this policy question in an environment in which there are recurring cycles of financial imbalances that develop over time and eventually collapse in a costly manner. The optimal policy reflects the trade-off between the short-run macroeconomic costs of leaning against the wind and the longer-run benefits of stabilising the financial cycle. We model the financial cycle as a nonlinear Markov regime-switching process, calibrate the model to US data and characterise the optimal monetary policy. Leaning systematically over the whole financial cycle is found to outperform policies of "benign neglect" and "late-in-the-cycle" discretionary interventions. This conclusion is robust to a wide range of alternative assumptions and supports an orientation shift in monetary policy frameworks away from narrow price stability to a joint consideration of price and financial stability.
Keywords: monetary policy; financial stability; leaning against the wind; financial cycle; time-varying transition probability Markov regime-switching model (search for similar items in EconPapers)
Pages: 44 pages
Date: 2016-12
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (92)
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Persistent link: https://EconPapers.repec.org/RePEc:bis:biswps:594
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