Leaning-Against-the-Wind: Which Policy and When?

Abstract This paper quantitatively examines which of the following three widely-used leaning-against-the-wind policies is effective in stabilizing aggregate fluctuations: i) a monetary policy that responds to the loan-to-GDP ratio, ii) a countercyclical LTV policy, and iii) a countercyclical capital requirement policy. In particular, we estimate a New Keynesian model with financial frictions using U.S. data and find that a monetary policy rule that responds positively to the loan-to-GDP ratio Amplifies the macroeconomic fluctuations while a countercyclical LTV policy has almost no effect. On the contrary, a countercyclical capital requirement policy is the most desirable in stabilizing GDP, inflation, and loans. However, the stabilization effect of the optimal countercyclical capital requirement policy is concentrated during periods in which financial shocks played a large role.