Monetary Policy and Financial Imbalances: Facts and Fiction

"Following the financial crisis, many have argued that monetary policy should lean against asset price increases and that deviations of credit and asset prices from trend can be used to capture financial imbalances. We study quarterly data spanning 1986-2008 for a sample of 18 countries and argue that such measures contain little information useful for forecasting the future economic conditions. This casts doubts on the leaning-against-the-wind view. We also argue that tightening monetary policy in response to such imbalances are likely to depress real growth substantially. That finding, however, is sensitive to the Lucas critique." Copyright (c) CEPR, CES, MSH, 2010.