“Cost-Benefit Analysis of Leaning Against the Wind : Are Costs Larger Also with Less Effective Macroprudential Policy?” revised January 2017. CEPR Discussion Paper DP11739 (Jan 2017), NBER Working Paper No. 21902 (Jan 2017). Previous versions: IMF Working Paper WP/16/3, January 2016.
“Leaning against the wind” (LAW) with a higher monetary policy interest rate may have benefits in terms of lower real debt growth and associated lower probability of a financial crisis but has costs in terms of higher unemployment and lower inflation, importantly including a higher cost of a crisis when the economy is weaker. For existing empirical estimates, costs exceed benefits by a substantial margin, even if monetary policy is nonneutral and permanently affects real debt. Somewhat surprisingly, less effective macroprudential policy, and generally a credit boom, with resulting higher probability, severity, or duration of a crisis, increases costs of LAW more than benefits, thus further strengthening the strong case against LAW.