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A quantitative case for leaning against the wind

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  • Andrew Filardo
  • Phurichai Rungcharoenkitkul

Abstract

Should a monetary authority lean against the build-up of financial imbalances? We study this policy question in an environment in which there are recurring cycles of financial imbalances that develop over time and eventually collapse in a costly manner. The optimal policy reflects the trade-off between the short-run macroeconomic costs of leaning against the wind and the longer-run benefits of stabilising the financial cycle. We model the financial cycle as a nonlinear Markov regime-switching process, calibrate the model to US data and characterise the optimal monetary policy. Leaning systematically over the whole financial cycle is found to outperform policies of "benign neglect" and "late-in-the-cycle" discretionary interventions. This conclusion is robust to a wide range of alternative assumptions and supports an orientation shift in monetary policy frameworks away from narrow price stability to a joint consideration of price and financial stability.

Suggested Citation

  • Andrew Filardo & Phurichai Rungcharoenkitkul, 2016. "A quantitative case for leaning against the wind," BIS Working Papers 594, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:594
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    References listed on IDEAS

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    More about this item

    Keywords

    monetary policy; financial stability; leaning against the wind; financial cycle; time-varying transition probability Markov regime-switching model;
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