Discussion of ”Should monetary policy lean against the wind? An analysis based on a DSGE model with banking” by Leonardo Gambacorta and Federico M. Signoretti Paolo Gelain – Norges Bank Understanding Macroprudential Regulation Workshop Norges Bank – November 2012

About the paper (1) Consensus before the crisis: central bank should pay no attention to financial variables over and above their effects on inflation – Usual arguments (Mishkin 2011) inability of the central bank to correctly identify bubbles lack of effectiveness of the policy rate to contain asset price movements strong easing of policy would be sufficient to “clean up” after the burst of a bubble

Extra argument – The theoretical underpinnings of the pre-crisis consensus (e.g. Iacoviello 2005, Bernanke and Gertler 2001) grounded on financial frictions only on the borrowers’ side of credit markets If the supply side of credit markets is also modeled central bank can have a substantial gain in ”leaning against the wind” About the paper (2)

Comment 1 IJCB conference “New Frameworks for Monetary Policy Analysis in an Era of Crises” Sept John Leahy – Non-linearities – Departure from rational expectations hypothesis (as a tool to get boom-bust mechanism) Central Bank Macroeconomic Modeling Workshop – Warsaw Sept Claudio Borio – Our models are missing some key features (e.g. endogenous financial cycle, non-fully rational agents)

Comment 2 One key element: asset price dynamics

Is the asset price dynamics in the model in line with the empirical evidence? 1)What do we know about asset prices? They display excess volatility – Shiller (1981) and LeRoy and Porter (1981) 2) What about this paper? Not clear! Model is basically GNSS (2011) JMCB. Does the estimated model capture the correct asset price dynamics? Unlikely because – Asset prices are not an observable – There are not mechanisms to account for excess volatility

Is it relevant to account for excess volatility? Gelain, Lansing, and Mendicino (2012) House Prices, Credit Growth, and Excess Volatility: Implications for Monetary and Macroprudential Policy – Show that introducing moving-average expectations helps to account house prices volatility – LATW policy which are ineffective under rational expectations might be destabilizing under moving- average expectations – LATW policy which are stabilizing under rational expectations might be ineffective under moving- average expectations

Is it relevant to account for excess volatility? Gali (2011) Monetary Policy and Rational Asset Price Bubbles – A systematic increase in interest rates in response to a growing bubble is shown to enhance the fluctuations in the latter – The optimal monetary policy seeks to strike a balance between stabilization of the bubble and stabilization of aggregate demand and this might lead monetary policy to decrease interest rate more in boom phase

Comment 3 – Taylor principle Taylor principle seems to disappear from the model Response coefficient to inflation goes from 0.01 to 5 and there is never indeterminacy We know that Taylor principle can be – inverted, e.g. Bilbiie (2008) JET – altered, e.g. Ascari and Ropele (2009) JMCB What is happening here? – Surely related to the supply side!

Minor comments 1.Which are the parameters values? 2.Are they from GNSS (2011)? The structure of the model changes here, so maybe GNSS values are not appropriate 3.Why focusing only on technology and cost push shock? Are they the most relevant in GNSS? 4.Why banking sector with pro-cyclical bank leverage? 5.Wouldn’t be a welfare based measure better than the CB loss? Most likely yes.

Conclusions Interesting paper on a relevant topic Try to check the asset price dynamics – Best strategy introduce boom-bust mechanism Spend some words on the Taylor principle Fix minor issues

Thanks