Leaning Against the Wind When Credit Bites Back

Karsten R. Gerdrup, Frank Hansen, Tord Krogh and Junior Maih
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Karsten R. Gerdrup: Norges Bank
Frank Hansen: Norges Bank
Tord Krogh: Norges Bank

International Journal of Central Banking, 2017, vol. 13, issue 3, 287-320

Abstract: This paper analyzes the cost-benefit trade-off of leaning against the wind (LAW) in monetary policy. Our starting point is a New Keynesian regime-switching model where the economy can be in a normal state or in a crisis state. The setup enables us to weigh benefits against costs for different systematic LAW policies. We find that the benefits of LAW in terms of a lower frequency of severe financial recessions exceed costs in terms of higher volatility in normal times when the severity of a crisis is endogenous (when “credit bites back”). Our qualitative results are robust to alternative specifications for the probability of a crisis. Our results hinge on the endogeneity of crisis severity. When the severity of a crisis is exogenous, we find that, if anything, it is optimal to lean with the wind.

Date: 2017
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Citations: View citations in EconPapers (19)

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Related works:
Working Paper: Leaning against the wind when credit bites back (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:ijc:ijcjou:y:2017:q:3:a:8

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