Lean-Against-the-Wind Monetary Policy: The Post-Crisis Shift in the Literature

The debate concerning central banks' response to potential asset price bubbles initially referred to whether monetary policy should respond at a level over and above the one warranted by the objectives of inflation and output gap stability, trying to slow the growth of perceived asset price bubbles, so as to minimise the adverse effects when the latter burst (the "lean-against-the-wind" -LATW- view). Alternatively, it argued whether it should respond to declines in asset prices only after the bubble bursts (often termed as conventional or "cleaning-up" view), in order to stabilise both output and inflation. The article reviews the shift in the monetary policy literature addressing the above debate in the aftermath of the global financial crisis, and demonstrates that this shift has been in favour of the LATW view. In particular, we contend that the pre-crisis conventional view has incorporated elements of the opposing view, in that it addresses financial frictions in the models of the economy used for the design and conduct of monetary policy. In addition, even the LATW view has altered, in that it advocates further co-operation between monetary and macroprudential policies; the latter designed to promote and ensure financial stability.