Description

We introduce time-varying systemic risk in an otherwise standard New-Keynesianmodel to study whether a simple leaning-against-the-wind policy can reduce systemic riskand improve welfare. We find that an unexpected increase in policy rates reduces output,inflation, and asset prices without fundamentally mitigating financial risks. We also find thatwhile a systematic monetary policy reaction can improve welfare, it is too simplistic: (1) it ishighly sensitive to parameters of the model and (2) is detrimental in the presence of fallingasset prices. Macroprudential policy, similar to a countercyclical capital requirement, is morerobust and leads to higher welfare gains.

More publications in this series: Working Papers

More publications by: Stefan Laseen ; Andrea Pescatori ; Jarkko Turunen