The Trade Offs in Leaning Against the Wind

46 Pages Posted: 24 Apr 2018

See all articles by Francois Gourio

Francois Gourio

Federal Reserve Bank of Chicago

Jae Sim

Board of Governors of the Federal Reserve System

Anil K. Kashyap

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

Date Written: March 2018

Abstract

Credit booms sometimes lead to financial crises and subsequent severe and persistent economic slumps. So should monetary policy “lean against the wind” and counteract excess credit growth, or should it focus only on inflation and output stability? We study this issue quantitatively in a small New Keynesian dynamic stochastic general equilibrium model in which the risk of financial crises depends on “excess credit.” We compare monetary policy rules responding to the output gap to rules that respond to excess credit. We find that responding to credit can lead to a lower average probability of financial crisis, at the cost of higher cyclical volatility in inflation and output. We discuss the factors that affect the desirability of leaning against the wind.

Suggested Citation

Gourio, Francois and Sim, Jae W. and Kashyap, Anil K., The Trade Offs in Leaning Against the Wind (March 2018). IMF Economic Review, Vol. 66, Issue 1, 2018. Available at SSRN: https://ssrn.com/abstract=3162100 or http://dx.doi.org/10.1057/s41308-017-0043-3

Francois Gourio (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

HOME PAGE: http://sites.google.com/site/fgourio

Jae W. Sim

Board of Governors of the Federal Reserve System ( email )

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

Anil K. Kashyap

University of Chicago, Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7260 (Phone)
773 702-0458 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
773-702-7260 (Phone)
773-702-0458 (Fax)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

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