The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma
47 Pages Posted: 27 Aug 2019
Date Written: November 2018
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 of our theory 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 acting as a more stringent constraint than the Zero Lower Bound. 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 under which the ELB may arise, the first featuring carry-trade capital flows and the second highlighting the role of currency mismatches.
Keywords: Monetary policy, Capital flows, Interest rates, Currency mismatches, Spillovers, Open economies, Central banking and monetary issues, Financial crises, Central banks, Financial markets, Central bank aggregates, collateral constraints, carry trade, ELB, lend rate, capital flow, contractionary, government bond
JEL Classification: E50, F30, F42, E5, F3, G21, E01, E52, O24
Suggested Citation: Suggested Citation