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BCAM 1402
Giovanni Melina and Stefania Villa
Leaning Against Windy Bank Lending

Using a dynamic stochastic general equilibrium model with banking, this paper first provides evidence that, during the Great Moderation, monetary policy leaned against the wind blowing from the loan market in the US. It then shows that the extent to which this occurred delivers a small welfare loss relative to the optimised simple interest-rate rule that features only a response to inflation. The source of business cycle fluctuations is crucial for the optimality of a leaning-against-the-wind policy. In fact, the pro-cyclical nature of lending creates a trade-off between inflation and financial stabilisation when supply shocks are prevalent.

Keywords: lending relationships, augmented Taylor rule, Bayesian estimation, optimal policy.

JEL Codes: E32, E44, E52

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