Inflation targeting and leaning against the wind

Inflation targeting and leaning against the wind,” in South African Reserve Bank (2015), Fourteen Years of Inflation Targeting in South Africa and the Challenge of a Changing Mandate: South African Reserve Bank Conference Proceedings 2014. Pretoria: South African Reserve Bank, 19-36. Paper. SlidesProgram

A previous version, Why Leaning Against the Wind Is the Wrong Monetary Policy for Sweden,” was presented at the NBER 25th Annual East Asian Seminar on Economics, Unconventional Monetary Policy, Tokyo, June 20-21, 2014.
A shorter version, “Inflation Targeting and Leaning Against the Wind,” is published in International Journal of Central Banking (June 2014)  103-114.


Should inflation targeting involve some leaning against the wind? Leaning against the wind – a tighter monetary policy than is justified for stabilising inflation around an inflation target and resource utilisation around a long-run sustainable rate – has been advocated as a policy to counter rapid credit growth and rising asset prices. Sweden provides a case study, as the Riksbank has been leaning against the wind quite aggressively since 2010, stating concerns about risks associated with household indebtedness. The cost of this policy is high, in the form of inflation much below the target and a higher unemployment rate, arguably as much as 1,2 percentage points higher than necessary. In contrast, according to the Riksbank’s own calculations, the benefit of a higher policy rate in terms of a lower probability and less severity of a future crisis is miniscule. Expressed in the form of a lower expected future unemployment rate, the benefit is only about 0,004 of the cost in the form of a higher unemployment rate over the next few years. Furthermore, much lower inflation than expected has actually substantially increased households’ debt burden and, if anything, increased any risks. Since the fall of 2011, the real value of a given loan has become almost 6 per cent larger than if inflation had been on target.

JEL codes: E52, E58, G21.