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

19 Pages Posted: 6 Sep 2017 Last revised: 19 May 2024

See all articles by Lars E. O. Svensson

Lars E. O. Svensson

Stockholm School of Economics; Stockholm University - Institute for International Economic Studies (IIES); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

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Date Written: August 2017

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.

Suggested Citation

Svensson, Lars E.O., Leaning Against the Wind: The Role of Different Assumptions About the Costs (August 2017). NBER Working Paper No. w23745, Available at SSRN: https://ssrn.com/abstract=3031716

Lars E.O. Svensson (Contact Author)

Stockholm School of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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