Cost-Benefit Analysis of Leaning Against the Wind

37 Pages Posted: 15 Aug 2019

See all articles by Trent Saunders

Trent Saunders

Reserve Bank of Australia

Peter Tulip

Reserve Bank of Australia

Date Written: July 11, 2019

Abstract

Setting interest rates higher than macroeconomic conditions would warrant due to concerns about financial instability is called ‘leaning against the wind’. Many recent papers have attempted to quantify and evaluate the effects of this policy. This paper summarises this research and applies the approach to Australia.

The papers we survey see the benefit of leaning against the wind as avoiding financial crises, such as those that affected Australia in 1990 or other countries in 2008. Most of the international research finds that interest rates have too small an effect on the probability of a crisis for this benefit to be worth higher unemployment. Using Australian data, we find similar results. We estimate the costs of leaning against the wind to be three to eight times larger than the benefit of avoiding financial crises. However, research has not yet quantified the increased resilience of household balance sheets, which may be an extra benefit of leaning against the wind.

Keywords: financial stability, monetary policy, evidence-based policy

JEL Classification: E52, E58, G18

Suggested Citation

Saunders, Trent and Tulip, Peter, Cost-Benefit Analysis of Leaning Against the Wind (July 11, 2019). Available at SSRN: https://ssrn.com/abstract=3435992 or http://dx.doi.org/10.2139/ssrn.3435992

Trent Saunders

Reserve Bank of Australia ( email )

65, Martin Place
Sydney, NSW 2000
Australia

Peter Tulip (Contact Author)

Reserve Bank of Australia ( email )

GPO Box 3947
Sydney, NSW 2001
Australia
61-2-9551-8831 (Phone)

HOME PAGE: http://www.petertulip.com

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