The Tradeoffs in Leaning Against the Wind

45 Pages Posted: 11 Aug 2017

See all articles by Francois Gourio

Francois Gourio

Federal Reserve Bank of Chicago

Anil K. Kashyap

University of Chicago, Booth School of Business; National Bureau of Economic Research (NBER); Federal Reserve Bank of Chicago

Jae Sim

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: August 2017

Abstract

Credit booms sometimes lead to financial crises which are accompanied with severe and persistent economic slumps. Does this imply that monetary policy should “lean against the wind” and counteract excess credit growth, even at the cost of higher output and inflation volatility? We study this issue quantitatively in a standard small New Keynesian dynamic stochastic general equilibrium model which includes a risk of financial crisis that depends on “excess credit”. We compare monetary policy rules that respond to the output gap with rules that respond to excess credit. We find that leaning against the wind may be attractive, depending on several factors, including (1) the severity of financial crises; (2) the sensitivity of crisis probability to excess credit; (3) the volatility of excess credit; (4) the level of risk aversion.

Suggested Citation

Gourio, Francois and Kashyap, Anil K. and Sim, Jae W., The Tradeoffs in Leaning Against the Wind (August 2017). NBER Working Paper No. w23658. Available at SSRN: https://ssrn.com/abstract=3016929

Francois Gourio (Contact Author)

Federal Reserve Bank of Chicago ( email )

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Anil K. Kashyap

University of Chicago, Booth School of Business ( email )

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National Bureau of Economic Research (NBER) ( email )

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Federal Reserve Bank of Chicago ( email )

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Chicago, IL 60604
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Jae W. Sim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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