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

Lars Svensson

No 12249, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: Monetary policy; Financial stability; Macroprudential policy; Financial crises (search for similar items in EconPapers)
JEL-codes: E52 E58 G01 (search for similar items in EconPapers)
Date: 2017-08
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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