The nonlinear case against leaning against the wind

We re-examine the relationship between monetary policy and financial stability in a setting that allows for nonlinear, time-varying relationships between monetary policy, financial stability, and macroeconomic outcomes. Using novel machine-learning techniques, we estimate a flexible "nonlinear VAR" for the stance of monetary policy, real activity, inflation, and financial conditions, and evaluate counterfactual evolutions of downside risk to real activity under alternative monetary policy paths. We find that a tighter path of monetary policy in 2003-05 would have increased the risk of adverse real outcomes three to four years ahead, especially if the tightening had been large or rapid. This suggests that there is limited evidence to support "leaning against the wind" even once one allows for rich nonlinearities, intertemporal dependence, and crisis predictability.