The Open-Economy Elb: Contractionary Monetary Easing and the Trilemma

58 Pages Posted: 8 May 2020

See all articles by Paolo Cavallino

Paolo Cavallino

Bank for International Settlements (BIS)

Damiano Sandri

International Monetary Fund (IMF) - Research Department

Date Written: April 2020

Abstract

Contrary to the trilemma, we show that international financial integration can undermine the transmission of monetary policy even in countries with flexible exchange rates due to an open-economy Effective Lower Bound. The ELB is an interest rate threshold below which monetary easing becomes contractionary due to the interaction between capital flows and collateral constraints. A tightening in global monetary and financial conditions increases the ELB and may prompt central banks to hike rates despite output contracting. We also show that the ELB gives rise to a novel inter-temporal trade-off for monetary policy and calls for supporting monetary policy with additional policy tools.

Keywords: carry trade, Collateral constraints, Currency mismatches, monetary policy, Spillovers

JEL Classification: E5, F3, F42

Suggested Citation

Cavallino, Paolo and Sandri, Damiano, The Open-Economy Elb: Contractionary Monetary Easing and the Trilemma (April 2020). CEPR Discussion Paper No. DP14683, Available at SSRN: https://ssrn.com/abstract=3594316

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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