PAOLO CAVALLINO 

EMPLOYMENT

     2022 - present  Bank for International Settlements, Senior Economist 

     2018 - 2022  Bank for International Settlements, Economist 

     2015 - 2018  International Monetary Fund, Economist (Economist Program)

EDUCATION

    2009 - 2015   Ph.D in Economics – New York University, New York

    2006 - 2009   M.Sc. in Economics and Social Sciences – Bocconi, Milan

    2003 - 2006   B.A. in Public Relations and Advertising - IULM University, Milan

Open Curriculum Vitae

2023 Fall Advanced International Macroeconomics (PhD level), The Graduate Institute Geneva

2022 Fall Advanced International Macroeconomics (PhD level), The Graduate Institute Geneva

2021 Fall Advanced International Macroeconomics (PhD level), The Graduate Institute Geneva

2020 Fall Advanced International Macroeconomics (PhD level), The Graduate Institute Geneva

2011 Summer Money and Banking (Bachelor level), New York University

WORK IN PROGRESS

Paolo Cavallino,  Fiorella de Fiore, Maximilian Grimm, and Frank Smets (2024). "Monetary and fiscal policy interactions for financial stability."

This paper examines the interaction between monetary and fiscal policy through their effects on financial market conditions, both theoretically and empirically. Monetary and fiscal policy influence the allocation directly through changes in their instruments and indirectly by impacting banks’ balance sheets and credit availability.  Monetary policy can affect the economy through two channels for a given fiscal stance. First, higher policy rates increase government borrowing costs, reducing the value of bonds on banks’ balance sheets. This tightens banks’ leverage constraints and limits their ability to raise deposits for credit. Second, quantitative tightening raises the share of bonds held by the private sector, further tightening banks’ leverage constraints, similar to a rate hike. Fiscal policy that increases public debt also tightens banks’ leverage constraints for a given monetary stance, increasing private sector bond holdings and adversely impacting credit and real activity.

Paul Beaudry, Paolo Cavallino,  and Tim Willems (2024). "Life-cycle forces make monetary policy transmission wealth-centric." [pdf]

This paper adds life-cycle features to a New Keynesian model and shows how this places financial wealth at the center of consumption/saving decisions, thereby enriching the determinants of aggregate demand and affecting the transmission of monetary policy. As retirement preoccupations strengthen, the potency of conventional monetary policy declines and depends more on the response of asset prices (supporting central banks closely monitoring the impact of monetary policy on asset prices). Especially “low/high for long” policies are shown to often have only muted effects on economic activity due to offsetting income and substitution effects of interest rates, in a way that can be compounded by Quantitative Easing. We also show why the presence of life-cycle forces can favor a monetary policy strategy which stabilizes asset prices in response to financial shocks. Being explicit about the role of retirement savings in aggregate demand therefore offers new perspectives on several aspects of monetary interventions.

Paolo Cavallino,  and Jeongwon Son (2023). "Sudden Stops and the macro-prudential role of monetary policy."

This paper examines the impact of large capital flows on emerging market economies. Large capital outflow episodes reduce economic activity and restrict private sector credit supply while large capital inflows stimulate economic activity and credit supply. Sudden Stops, large capital outflow episodes with reductions in credit supply larger than 5%, primarily drive the effect of large capital outflow episodes. We also find inflows predict outflows and Sudden Stops even after controlling for credit supply. We construct a small open economy model with occasionally binding constraints that accounts for these stylized facts. Sudden stops are driven by an increase in the asset holdings of domestic banks following capital flight of foreign investors. When banks’ leverage constraint becomes binding, the capital flight causes a domestic credit crunch and a severe recession. The optimal monetary policy has a macro-prudential component and leans against the accumulation of domestic and external debt.

Paolo Cavallino and Boris Hofmann (2022). "Capital Flows and Monetary Policy Trade-offs in Emerging Market Economies. " [pdf]

We lay out a small open economy model incorporating key features of EME economic and financial structure: high exchange rate pass-through to import prices, low passthrough to export prices and shallow domestic financial markets giving rise to occasionally binding leverage constraints. As a consequence of the latter, a sudden stop with large capital outflows can give rise to a financial crisis. In the sudden stop, the central bank faces an intratemporal trade-off as output declines while inflation rises. In normal times, there is an intertemporal trade-off as the risk of a future sudden stop forces the central bank to factor financial stability considerations into its policy conduct. The optimal monetary policy leans against capital flows and domestic leverage. Macroprudential, capital flow management and central bank balance sheet policies can help to mitigate both intra- and intertemporal trade-offs. Fiscal policy also plays a key role. A higher level of public debt and a weaker fiscal policy imply greater leverage and hence greater tail risk for the economy. 

Alberola Enrique, Carlos Cantú, Paolo Cavallino, and Nikola Mirkov (2021). "Fiscal Regimes and the Exchange Rate." [pdf] Reject and Resubmit, JIE

Media coverage:  VoxEU | Central Banking | Valor Econômico

In this paper, we argue that the effect of monetary and fiscal policies on the exchange rate depends on the fiscal regime. A contractionary monetary (expansionary fiscal) shock can lead to a depreciation, rather than an appreciation, of the domestic currency if debt is not backed by future fiscal surpluses. We look at daily movements of the Brazilian real around policy announcements and find strong support for the existence of two regimes with opposite signs. The unconventional response of the exchange rate occurs when fiscal fundamentals are deteriorating and markets' concern about debt sustainability is rising. To rationalize these findings, we propose a model of sovereign default in which foreign investors are subject to higher haircuts and fiscal policy shifts between Ricardian and non-Ricardian regimes. In the latter, sovereign default risk drives the currency risk premium and affects how the exchange rate reacts to policy shocks.

JOURNAL ARTICLES

Cavallino, Paolo, and Damiano Sandri (2023). "The Open-Economy ELB: Contractionary Monetary Easing and the Trilemma." Journal of International Economics,  140: 103691 [pdf] 

Media coverage: Central Banking

Contrary to Mundell's trilemma, we show that free capital mobility may prevent monetary policy from ensuring output stability even if the exchange rate is flexible due to the existence of an Effective Lower Bound. The ELB is an interest rate threshold below which monetary easing becomes contractionary because of adverse effects on credit supply. A tightening in global monetary and financial conditions increases the ELB and may force central banks to hike rates even though domestic economic activity contracts. We also show that the ELB gives rise to a novel inter-temporal trade-off for monetary policy and calls for using a broad range of policy tools to restore monetary transmission. 

Cavallino, Paolo (2019). "Capital Flows and Foreign Exchange Intervention." American Economic Journal: Macroeconomics, 11(2):127-70 [pdf]  

I consider a New Keynesian model of a small open economy where international financial markets are imperfect and the exchange rate is determined by capital flows. I use this framework to study the effects of exchange rate fluctuations driven by capital flows and characterize the optimal foreign exchange intervention. Capital flow shocks cause inefficient exchange rate fluctuations that trigger boom-bust cycles in the domestic economy. The optimal policy response is to use both foreign exchange intervention and monetary policy to stabilize the economy. Foreign exchange intervention “leans against the wind” and stabilizes the path of the exchange rate, while monetary policy corrects the inefficiencies caused by price rigidity. The two tools are complements rather than substitutes. I derive the optimal foreign exchange intervention rule in closed form as a function of three implicit targets: a wedge in the Backus-Smith condition, domestic net foreign assets, and the level of foreign reserves. Finally, using Swiss data I provide evidence of the inefficiencies generated by capital flow shocks and quantify them by estimating the financial market friction that determines deviations from uncovered interest rate parity.

POLICY PAPERS

Cavallino, Paolo, Giulio Cornelli, Peter Hördahl and Egon Zakrajsek  (2022). "Front-loading monetary tightening: pros and cons." BIS Bulletin, No 63 [link]

Central banks in advanced economies reacted swiftly and forcefully to the Covid-19 pandemic, deploying the full range of crisis tools within weeks. The initial response focused primarily on easing financial stress and ensuring a smooth flow of credit to the private non-financial sector. The pandemic triggered complementary responses from monetary and fiscal authorities. Fiscal backstops and loan guarantees supported central bank actions. Asset purchases, designed to achieve central banks’ objectives, helped contain the costs of fiscal expansions. The footprint of central banks’ measures will be sizeable. Across the five largest advanced economies, balance sheets are projected to grow on average by 15–23% of GDP before end-2020 and to remain large in the near future. 

Cantú Carlos, Paolo Cavallino, Fiorella de Fiore, and James Yetman (2021). "A Global Database on Central Banks' Monetary Responses to Covid-19.", BIS Working Paper, No 934 [link]

Media coverage: Central Banking | BISness podcast

The Covid-19 pandemic has been a global shock of unprecedented size that has hit most countries around the world. Central banks have responded quickly, on a massive scale. We present a novel database that provides information on central banks’ responses to Covid-19 in 39 economies, including both advanced and emerging market economies. Monetary policy announcements are listed and classified under five types of tools: interest rate measures, reserve policies, lending operations, asset purchase programmes and foreign exchange operations. Within each category, the database provides additional information such as maturity, eligible counterparties, types of assets and the availability of fiscal backup. It also indicates whether the policy tool was newly introduced or had been previously deployed. The database has a companion dashboard to visualise the data graphically. 

Cavallino, Paolo and Fiorella de Fiore (2020). "Central banks' response to Covid-19 in advanced economies." BIS Bulletin, No 21 [link]

Media coverage: Il Sole 24 Ore | Central Banking | Valor Econômico

Central banks in advanced economies reacted swiftly and forcefully to the Covid-19 pandemic, deploying the full range of crisis tools within weeks. The initial response focused primarily on easing financial stress and ensuring a smooth flow of credit to the private non-financial sector. The pandemic triggered complementary responses from monetary and fiscal authorities. Fiscal backstops and loan guarantees supported central bank actions. Asset purchases, designed to achieve central banks’ objectives, helped contain the costs of fiscal expansions. The footprint of central banks’ measures will be sizeable. Across the five largest advanced economies, balance sheets are projected to grow on average by 15–23% of GDP before end-2020 and to remain large in the near future. 

Cavallino, Paolo and Nikhil Patel (2019). "FX intervention: goals, strategies and tactics." BIS Paper, No 104b [link]

Foreign exchange intervention is an important tool for central banks in many emerging market economies (EMEs). Drawing on a recent survey of 21 EME central banks as well as inputs from their contributions published in this volume, this paper summarises the main issues with regard to FX intervention. It focusses on the goals, channels, effectiveness and the different methods and tactics used by central banks. It leverages data from similar surveys conducted in the past to illustrate how central banks’ views and conduct have evolved over the years along each of these dimensions. 

OLD PROJECTS 

Cavallino, Paolo, and Divya Kirti. "Optimal Lender of Last Resort Policy and the Zero Lower Bound."

We model the interaction between Lender of Last Resort (LOLR) policy and the natural rate of interest. When the LOLR is less likely to intervene, or the cost for the borrower is high, the desire to self-insure from rollover risk increases. The higher demand for safe assets reduces their interest rates and might push the natural rate into negative territory. Once its effect on the ZLB is taken into account, the optimal LOLR policy is more proactive and features milder conditionality.

Cavallino, Paolo, and Atish R. Ghosh. "Currency Wars and Unconventional Monetary Policies."

In this paper, we develop a theoretical framework for analyzing cross-border spillovers of unconventional policy instruments (QE, FXI) in a two-large country, or one-large, multiple-small country, settings. The model is used to consider the costs of “currency wars” and the benefits of cross-country cooperation in the setting of unconventional monetary policies. We show how QE has positive spillovers while FXI has negative spillovers to other countries. 

Cavallino, Paolo. "Asset Pricing with Financial Frictions." [pdf]

In this paper I explore the relationship between financial frictions and asset prices in a closed economy model, and study the implications for the leverage cycle of financial intermediaries. I develop a continuous-time dynamic macroeconomic model with heterogeneous agents and limited stock market participation. Risk averse households can invest in the stock market only through financial intermediaries. Financiers raise funds from households by issuing risk-free debt or outside equity and invest in the stock market.  An agency friction limits the amount of outside equity that the financier can issue and constraints risk-sharing among agents. The model generates procyclical leverage during normal times while countercyclical leverage when the equity constraint binds and replicates the non-linearity of equity premia observed during financial crises. I calibrate the model to match features of the financial intermediation sector, such as average debt-to-assets ratio and a measure of financial manager compensation, and show that the simulated asset prices moments are close to those observed in the data.