Leaning against the Wind and Crisis Risk

Abstract

Can central banks defuse rising stability risks in financial booms by leaning against the wind with higher interest rates? This paper studies the state-dependent effects of monetary policy on financial crisis risk. Based on the near-universe of advanced economy financial cycles since the nineteenth century, we show that discretionary leaning against the wind policies during credit and asset price booms are more likely to trigger crises than prevent them. (JEL E43, E44, E52, E58, F33)

Leaning Against Persistent Financial Cycles with Occasional Crises

“…Although higher long-run capital requirements slightly reduce the time spent in crisis episodes, they mitigate crisis severity and lead to a faster recovery from crises. This result is in line with the empirical results in Jordà et al (2021) and Schularick et al (2020). Furthermore, we find that higher long-run capital requirements significantly lower the probability of a binding ELB by bringing the mean inflation rate closer to the inflation target.…”

The Vagaries of the Sea: Evidence on the Real Effects of Money from Maritime Disasters in the Spanish Empire

“…This picture is echoed in the historical literature.Morineau (1985, p.69) describes how the loss of the 1622 fleet sparked panic in Seville. More recently, the empirical evidence presented bySchularick, ter Steege, and Ward (2021) highlights the potency of contractionary monetary shocks in triggering financial crises.35 Appendix A.3.3 explores the concern that in the aftermath of maritime disasters, bills of exchange prices reflected merchants' fears of currency debasement, rather than Spanish lending rate fluctuations. When we calculate lending rates from bill prices in a way that eliminates the devaluation risk component,…”

Financial Globalization and Bank Lending: The Limits of Domestic Monetary Policy

“…By showing that the existence of a global funding channel makes domestic monetary policy less effective, especially when the central bank wants to tighten monetary policy and restrain a domestic credit boom, our analysis also illustrates a major channel that hampers lean against the wind monetary policies (Gourio, Kashyap, andSim (2018), Schularick, ter Steege, andWard (2020)), in particular in small open economies. This needs to be addressed when macroprudential policies are designed in order to contain excessive volatilities over credit cycles.…”