Should Monetary Policy "Lean or Clean"?

Abstract

It has been contended by many in the central banking community that monetary policy would not be effective in "leaning" against the upswing of a credit cycle (the boom) but that lower interest rates would be effective in "cleaning" up (the bust) afterwards. In this paper, these two propositions (can't lean, but can clean) are examined and found seriously deficient. In particular, it is contended in this paper that monetary policies designed solely to deal with short term problems of insufficient demand could make medium term problems worse by encouraging a buildup of debt that cannot be sustained over time. The conclusion reached is that monetary policy should be more focused on "preemptive tightening" to moderate credit bubbles than on "preemptive easing" to deal with the after effects. There is a need for a new macrofinancial stability framework that would use both regulatory and monetary instruments to resist credit bubbles and thus promote sustainable economic growth over time.

Assessing the Link between Price and Financial Stability

“…Woodford (2012) proposes only a marginal change in the way that the central bank should embrace a flexible inflation targeting strategy. Some, following White (2009), go a step further and ask for a "leaning against the wind policy".…”

The Relationship of Financial and Price Stability in the Context of the Czech Republic

“…Druhou skupinu tvoří již zmiňovaní představitelé strategie "leaning against the wind", kteří po propuknutí nedávné fi nanční krize získali další zastánce (Goodhart, 2010;White, 2009). Tato skupina ekonomů vidí příčinu fi nanční nestability v endogenních cyklech (Borio a Drehmann, 2009), které se projevují mj.…”

Monetary policy and asset prices: When cleaning up hits the zero lower bound

“…The essence of the cleaning-up approach as discussed in the literature so far (see, e.g., White, 2009) is that policymakers stabilize the economy optimally when an asset price boom has turned to bust but regard the build-up of a potentially unsustainable boom with benign neglect, such that they refrain from leaning against an upswing on asset markets. Only if and when a bust, with its ensuing drop in demand and inflation, occurs do policymakers react by cutting interest rates.…”