The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma

48 Pages Posted: 27 Feb 2019

See all articles by Paolo Cavallino

Paolo Cavallino

Bank for International Settlements (BIS)

Damiano Sandri

International Monetary Fund (IMF) - Research Department

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Date Written: February 21, 2019

Abstract

We provide a theory of the limits to monetary policy independence in open economies arising from the interaction between capital flows and domestic collateral constraints. The key feature is the existence of an "Expansionary Lower Bound" (ELB), defined as an interest rate threshold below which monetary easing becomes contractionary. The ELB can be positive, thus binding before the ZLB. Furthermore, the ELB is affected by global monetary and financial conditions, leading to novel international spillovers and crucial departures from Mundell's trilemma. We present two models in which the ELB may arise due to either carry-trade capital flows or currency mismatches.

Keywords: monetary policy, collateral constraints, currency mismatches, carry trade, spillovers

JEL Classification: E5, F3, F42

Suggested Citation

Cavallino, Paolo and Sandri, Damiano, The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma (February 21, 2019). BIS Working Paper No. 770. Available at SSRN: https://ssrn.com/abstract=3340268

Paolo Cavallino (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Damiano Sandri

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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