Leaning Against the Wind and Crisis Risk

Abstract

Can central banks defuse rising stability risks in financial booms by leaning against the wind with higher interest rates? This paper studies the state-dependent effects of monetary policy on financial stability. Based on the near-universe of advanced economy financial cycles since the 19th century, we show that discretionary leaning against the wind policies during credit and asset price booms are more likely to trigger crises than prevent them.

Keywords: financial crises, instrumental variable, open economy trilemma, local projections

JEL Classification: E440, E500, G010, G150, N100