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The Expansionary Lower Bound: Currency Mismatches and Monetary Spillovers

Author

Listed:
  • Damiano Sandri

    (International Monetary Fund)

  • Paolo Cavallino

    (International Monetary Fund)

Abstract

We develop a tractable model of monetary policy in emerging markets featuring currency mismatches and occasionally binding collateral constraints. We show that, if currency mismatches are severe, monetary policy is constrained in its ability to support output, even under flexible exchange rates. We characterize the existence of a strictly positive \expansionary lower bound" (ELB) on interest rates below which further monetary easing has contractionary effects. The ELB is affected by foreign monetary conditions that can in turn constrain domestic monetary policy. In particular, a US monetary tightening raises the ELB and can have recessionary consequences for emerging markets. As a result, a need for policy coordination arises. When the ELB is binding, social efficiency requires accepting some overheating in the US to reduce the contractionary effects on emerging markets.

Suggested Citation

  • Damiano Sandri & Paolo Cavallino, 2016. "The Expansionary Lower Bound: Currency Mismatches and Monetary Spillovers," 2016 Meeting Papers 1250, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:1250
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    References listed on IDEAS

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