Working Paper: NBER ID: w23658
Authors: Francois Gourio; Anil K Kashyap; Jae Sim
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.
Keywords: monetary policy; financial stability; credit growth; financial crises
JEL Codes: E52; E58; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| excess credit (E51) | probability of financial crisis (G01) |
| leaning against the wind (Y60) | likelihood of financial crises (G01) |
| failure to respond to excess credit (E51) | larger crisis risks (H12) |
| leaning against the wind (Y60) | stabilizing the economy (E63) |
| leaning against the wind (Y60) | increased volatility in output and inflation (E39) |