Should monetary policy lean against the wind?

Leonardo Gambacorta and Federico Signoretti

Journal of Economic Dynamics and Control, 2014, vol. 43, issue C, 146-174

Abstract: The global financial crisis has reaffirmed the importance of financial factors for macroeconomic fluctuations. Recent work has shown how the conventional pre-crisis prescription that monetary policy should pay no attention to financial variables over and above their effects on inflation may no longer be valid in models that consider frictions in financial intermediation (Cúrdia and Woodford, 2009). This paper analyzes whether Taylor rules augmented with asset prices and credit can improve upon a standard rule both in terms of macroeconomic stabilization and of agents׳ welfare in a DSGE with both a firms׳ balance-sheet channel and a bank-lending channel and in which the spread between lending and policy rates endogenously depends on banks׳ leverage. The main result is that, even in a model in which financial stability does not represent a distinctive policy objective, leaning-against-the-wind policies are desirable in the case of supply side shocks, while strict inflation targeting and a standard rule are less effective. The gains are amplified if the economy is characterized by high private sector indebtedness. Robustness shows that the interaction between financial frictions and debt-deflation effects is potentially very powerful.

Keywords: DSGE; Monetary policy; Asset prices; Credit channel; Taylor rule; Leaning-against-the-wind (search for similar items in EconPapers)
JEL-codes: E30 E44 E50 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (115)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S016518891400027X
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Should monetary policy lean against the wind? An analysis based on a DSGE model with banking (2013)
Working Paper: Should monetary policy lean against the wind? - an analysis based on a DSGE model with banking (2013)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:43:y:2014:i:c:p:146-174

DOI: 10.1016/j.jedc.2014.01.016

Access Statistics for this article

Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

More articles in Journal of Economic Dynamics and Control from Elsevier
Bibliographic data for series maintained by Catherine Liu ().