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The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma

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  • Paolo Cavallino
  • Damiano Sandri

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.

Suggested Citation

  • Paolo Cavallino & Damiano Sandri, 2018. "The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma," IMF Working Papers 18/236, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:18/236
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    References listed on IDEAS

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    1. Yusuf Soner Baskaya & Julian di Giovanni & Sebnem Kalemli-Özcan & Mehmet Fatih Ulu, 2017. "International spillovers and local credit cycles," Economics Working Papers 1559, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2017.
    2. Robert N. McCauley & Patrick McGuire & Vladyslav Sushko, 2015. "Global dollar credit: links to US monetary policy and leverage," Economic Policy, CEPR;CES;MSH, vol. 30(82), pages 187-229.
    3. Caballero, Julian & Panizza, Ugo & Powell, Andrew, 2015. "The second wave of global liquidity: Why are firms acting like financial intermediaries?," CEPR Discussion Papers 10926, C.E.P.R. Discussion Papers.
    4. Nicolas Arregui & Selim Elekdag & R. G Gelos & Romain Lafarguette & Dulani Seneviratne, 2018. "Can Countries Manage Their Financial Conditions Amid Globalization?," IMF Working Papers 18/15, International Monetary Fund.
    5. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
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    Cited by:

    1. Georgiadis, Georgios & Zhu, Feng, 2019. "Monetary policy spillovers, capital controls and exchange rate flexibility, and the financial channel of exchange rates," Working Paper Series 2267, European Central Bank.
    2. Salih Fendoğlu & Eda Gülşen & José-Luis Peydró, 0000. "Global liquidity and impairment of local monetary policy," Economics Working Papers 1680, Department of Economics and Business, Universitat Pompeu Fabra.
    3. Agur, Itai, 2019. "Monetary and macroprudential policy coordination among multiple equilibria," Journal of International Money and Finance, Elsevier, vol. 96(C), pages 192-209.
    4. repec:bkr:journl:v:78:y:2019:i:3:p:89-121 is not listed on IDEAS

    More about this item

    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:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F3 - International Economics - - International Finance
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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