Working Paper: CEPR ID: DP14683
Authors: Damiano Sandri; Paolo Cavallino
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: monetary policy; collateral constraints; carry trade; currency mismatches; spillovers
JEL Codes: E5; F3; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Global Financial Conditions (F65) | ELB (Y60) |
| ELB (Y60) | Central Bank Policy Rates (E52) |
| Monetary Easing (E52) | Capital Outflows (F32) |
| Capital Outflows (F32) | ELB (Y60) |
| ELB (Y60) | Output (Y10) |
| Bank Leverage Constraints (G21) | Monetary Transmission (E50) |
| Monetary Transmission (E50) | Output (Y10) |