Leaning Against the Wind: A Cost-Benefit Analysis for an Integrated Policy Framework

IMF Working Papers, July 7, 2020

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This paper assesses costs and benefits of using macroprudential, monetary, foreign exchange interventions, and capital flow management tools in response to changes in financial conditions.
Net benefits are evaluated using quadratic loss functions.
Policy effects on the full distribution of future output growth and inflation are estimated with quantile regressions.
Main comparative results:
- Tightening macroprudential policy dampens downside risks to growth stemming from loose financial conditions and is beneficial in net terms.
- Tightening monetary policy entails net losses, suggesting caution in using monetary policy to “lean against the wind.”
- These findings hold when policies respond to easing global financial conditions.
- Buying foreign exchange or tightening capital controls has small net benefits.

Uses quadratic loss functions to compute net benefits of policies.
Employs quantile regressions to estimate policy effects on the full distribution of future output growth and inflation.
Considers multiple policy instruments: macroprudential policy instruments, monetary policy (including monetary policy shock and monetary policy tightening), FX interventions, and capital flow management.

Macroprudential policy:
- Tightening macroprudential measures reduces downside growth risks associated with loose financial conditions.
- Overall net benefits from tightening macroprudential policy are positive.
Monetary policy:
- Tightening monetary policy produces net losses under the framework used.
- The results call for caution when using monetary policy to counteract financial-condition-driven risks ("leaning against the wind").
Foreign exchange interventions and capital flow management:
- Buying foreign exchange has small net benefits.
- Tightening capital controls has small net benefits.
Robustness:
- The comparative results remain when policies are used in response to easing global financial conditions.

Prioritize macroprudential tightening over monetary tightening when aiming to reduce downside growth risks from loose financial conditions.
Exercise caution in deploying monetary policy for financial-stability purposes given estimated net losses.
Recognize that FX interventions and capital flow management offer limited net benefits in the contexts analyzed.