Link to published version (Science Direct)
Data and Matlab program
A simple and transparent framework for cost-benefit analysis of “leaning against the wind” (LAW), that is, tighter monetary policy for financial-stability purposes, is presented. LAW has an obvious cost in the form of a weaker economy if no crisis occurs and possible benefits in the form of a lower probability and smaller magnitude of (financial) crises. A second cost—less obvious, overlooked by previous literature, but higher—is a weaker economy if a crisis occurs. For representative empirical benchmark estimates and reasonable assumptions the result is that the costs of LAW exceed the benefits by a substantial margin. The result is robust to alternative assumptions and estimates. A higher probability, larger magnitude, or longer duration of crises—typical consequences of ineffective macroprudential policy—all increase the margin of costs over benefits. To overturn the result, policy-interest-rate effects on the probability and magnitude of crises need to be more than 5–40 standard errors larger than the benchmark estimates.
“Monetary policy and macroprudential policy: Different and separate?” paper (revised March 2018), Canadian Journal of Economics, forthcoming. First version and and slides presented at the conference “Macroprudential monetary policy,” Federal Reserve Bank of Boston’s 59th Economic Conference, Federal Reserve Bank of Boston, October 2-3, 2015. Excel sheet used in slide 21 for the simple example of a cost-benefit analysis of leaning against the wind.
Monetary policy should stick to its core mandate of price stability, and should deviate from its traditional role only if the benefits to the economy outweigh the costs, according to a new study from the International Monetary Fund, “Monetary Policy and Financial Stability.”
The question is whether monetary policy should be altered to contain financial stability risks. Should it lend a hand by temporarily raising interest rates more than warranted by price and output stability objectives?
Based on our current knowledge, and in present circumstances, the answer is generally no.
“Forward guidance,” International Journal of Central Banking 11 (September 2015), Supplement 1, 19-64. New revision, now including the U.S. experience. Paper. Abstract.
Appendix: Slides for Sweden Feb 2007-Sep 2014, New Zealand Mar 2004-Mar 2014, U.S. Jan 2012-Mar 2017 (updated).
“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. Slides. Program. Continue reading
New publication: “The Possible Unemployment Cost of Average Inflation below a Credible Target,” American Economic Journal: Macroeconomics 7(1) (2015) 258-296.
Riksbankens mandat bör förtydligas, sysselsättningen ges större vikt, den demokratiska kontrollen av Riksbanken skärpas och koordineringen av penningpolitiken och makrotillsynen förbättras. Det skriver jag i den nya underlagsrapporten Penningpolitik och full sysselsättning för LOs projekt Full sysselsättning och solidarisk lönepolitik. Continue reading
New paper (revised August 31, 2013): “Some Lessons from Six Years of Practical Inflation Targeting,” revised, August 31, 2013. Previous version prepared for the Riksbank conference on “Two Decades of Inflation Targeting: Main Lessons and Remaining Challenges,” June 3, 2013. Paper (revised). Continue reading