PAOLO CAVALLINO


Economist at Bank for International Settlements

Centralbahnplatz 24051 Basel, Switzerland


Mobile: +41 76 350 85 22



CURRICULUM VITAE

Employment

2018 - present Bank for International Settlements

2015 - 2018 International Monetary Fund

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


RESEARCH

JOURNAL ARTICLES

Cavallino, Paolo. "Capital Flows and Foreign Exchange Intervention." American Economic Journal: Macroeconomics (Forthcoming) [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.

WORKING PAPERS

Cavallino, Paolo, and Damiano Sandri. "The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma." [pdf]

Media coverage: Central Banking

We provide a theory of the limits to monetary policy independence in financially integrated economies. We develop a model in which the interaction between capital flows and domestic borrowing constraints give rise to a new channel of monetary policy. In the model, a reduction in the domestic interest rate can trigger a capital outflow and lead to an increase in lending spreads. This new channel works in the opposite direction than the traditional ones and can give rise to an “Expansionary Lower Bound” (ELB), defined as the interest rate level below which monetary easing becomes contractionary. The ELB places an upper bound on the ability of monetary policy to stimulate domestic output. Importantly, the ELB can be positive and thus act as a more stringent constraint than the Zero Lower Bound. Furthermore, the ELB is affected by international monetary conditions. A monetary tightening in the US raises the ELB in emerging markets and pushes them into a recession. Our theory delivers crucial departures from the classical Mundell’s trilemma and provides novel implications for monetary policy spillovers and the effects of the global financial cycle. We provide two applications under which the ELB may arise. First, we consider a model with unhedged currency mismatches. In this case, domestic monetary easing can become contractionary because of the adverse balance sheet effects associated with the exchange rate depreciation. Second, the ELB can arise because of carry trade flows. When demand for emerging markets’ assets is sensitive to the domestic-foreign interest rate differential, domestic monetary easing triggers capital outflows that can make domestic constraints binding.


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.