The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma

The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma

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The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma

Author/Editor:

Paolo Cavallino
;
Damiano Sandri

Publication Date:

November 2, 2018

Electronic Access:

Free Full Text.

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary:

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.

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November 12, 2018 at 08:02PM https://ift.tt/2JzTsVk

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