Should Monetary Policy Lean Against the Wind? An Analysis Based on a DSGE Model with Banking

45 Pages Posted: 27 Feb 2014

See all articles by Leonardo Gambacorta

Leonardo Gambacorta

Bank for International Settlements (BIS); Centre for Economic Policy Research (CEPR)

Federico Maria Signoretti

Bank of Italy

Multiple version iconThere are 2 versions of this paper

Date Written: July 2013

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 in terms of macroeconomic stabilization 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 whenever the central bank is concerned with output stabilization, while both strict inflation targeting and a standard rule are less effective. The gains are amplified if the economy is characterized by high private sector indebtedness.

Keywords: DSGE, monetary policy, asset prices, credit channel, Taylor rule, leaning-against-the-wind

JEL Classification: E30, E44, E50

Suggested Citation

Gambacorta, Leonardo and Signoretti, Federico Maria, Should Monetary Policy Lean Against the Wind? An Analysis Based on a DSGE Model with Banking (July 2013). BIS Working Paper No. 418, Available at SSRN: https://ssrn.com/abstract=2353002

Leonardo Gambacorta (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Federico Maria Signoretti

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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