Leaning against persistent financial cycles with occasional crises

Working Papers from European Stability Mechanism

Abstract: We study conditions under which a leaning against the wind (LAW)-type monetary policy is advisable to address risks to financial stability. We do so within a regime-switching dynamic stochastic general equilibrium (DSGE) model with endogenous crises and persistent financial cycles based on partly backward-looking house price beliefs. Under empirically plausible financial cycles, LAW increases inflation volatility because it amplifies the effects of supply shocks on inflation. It also leads to a lower average inflation, resulting in more frequent episodes of a binding lower bound on interest rates. LAW is advisable only if (i) the central bank puts more weight on output stability or (ii) financial cycles are less persistent than observed.

Keywords: leaning against the wind; monetary policy; financial cycle; regime-switching DSGE (search for similar items in EconPapers)
JEL-codes: E52 E58 G01 (search for similar items in EconPapers)
Pages: 106
Date: 2023-04-04
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Published

Downloads: (external link)
https://www.esm.europa.eu/system/files/document/2023-04/WP%2056.pdf (application/pdf)

Related works:
Working Paper: Leaning against persistent financial cycles with occasional crises (2021)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:stm:wpaper:56

Access Statistics for this paper

More papers in Working Papers from European Stability Mechanism Contact information at EDIRC.
Bibliographic data for series maintained by Karol SISKIND ().