The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma

November 2, 2018

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Format: Chicago

Paolo Cavallino, and Damiano Sandri. The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma, (USA: International Monetary Fund, 2018) accessed December 22, 2024

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.

Subject: Balance of payments, Banking, Capital flows, Central bank policy rate, Exchange rates, Financial institutions, Financial services, Foreign exchange, Interest rate floor, Monetary policy, Sovereign bonds

Keywords: Capital flows, Carry trade, Central bank, Central bank policy rate, Collateral constraints, Credit crunch, Currency mismatches, ELB call, ELB constraint, ELB rise, Exchange rate, Exchange rates, Existence of an Expansionary Lower Bound, Global, Interest rate floor, Monetary policy, Monetary policy in EMs, Monetary policy independence, Monetary policy rate, Monetary policy stance, Open economy, Policy rate response, Sovereign bonds, Spillovers, WP

Publication Details

Pages:

46
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2018/236
Stock No:

WPIEA2018236
ISBN:

9781484381618
ISSN:

1018-5941

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