The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma

47 Pages Posted: 27 Aug 2019

See all articles by Paolo Cavallino

Paolo Cavallino

Bank for International Settlements (BIS)

Damiano Sandri

International Monetary Fund (IMF) - Research Department

Multiple version iconThere are 2 versions of this paper

Date Written: November 2018

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 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

Cavallino, Paolo and Sandri, Damiano, The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma (November 2018). IMF Working Paper No. 18/236. Available at SSRN: https://ssrn.com/abstract=3442856

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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