DOCSLIB.ORG

The Trilemma, Aka the “Impossible Trinity”

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
The Trilemma, Aka the “Impossible Trinity” Public Affairs 854 Menzie D. Chinn Spring 20 13 Social Sciences 7418 University of Wisconsin-Madison The Trilemma, aka the “Impossible Trinity” http://www.brookings.edu/papers/1999/06development_frankel.aspx Figure 1: Definitions of Nine Major Exchange Rate Regimes, Ranged Along the Continuum from the Most Flexible to the Strongest Fixed-Rate Commitment FLEXIBLE CORNER 1. Free floating--the absence of regular intervention in the foreign exchange market 2. Managed float--the absence of a specific target for the exchange rate INTERMEDIATE REGIMES 3. Target zone, or band--a margin of fluctuation around some central rate 4. Basket peg--fixing not to a single foreign currency but to a weighted average of other currencies 5. Crawling peg--a preannounced policy of devaluing a bit each week 6. Adjustable peg--fixing the exchange rate, but without any open-ended commitment to resist devaluation or revaluation in the presence of a large balance of payments deficit or surplus FIXED CORNER 7. Truly fixed peg--fixing, committing to buy or sell however much foreign currency is necessary at a given exchange rate, with a firm and lasting intention of maintaining the policy 8. Currency board--three defining characteristics: fixing not just by policy but by law, backing increases in the monetary base one-for-one with foreign exchange reserves, and allowing balance of payments deficits to tighten monetary policy and thereby adjust spending automatically 9. Monetary union--the adoption of a foreign currency as legal tender. This includes the special case of official dollarization Figure 1: The Trilemma and International Reserves Configurations over Time Industrialized Countries Non-Euro Industrialized Countries Monetary Independence Monetary Independence Financial Integration Exchange Rate Stability Financial Integration Exchange Rate Stability .2 .2 .4 1971-80 .4 1971-80 .6 1981-90 .6 1981-90 1991-2000 1991-2000 .8 2001-06 .8 2001-06 1 1 International Reserves/GDP International Reserves/GDP Center is at 0 Center is at 0 Emerging Market Countries Non-Emerging Market Developing Countries Monetary Independence Monetary Independence Financial Integration Exchange Rate Stability Financial Integration Exchange Rate Stability .2 .2 .4 1971-80 .4 1971-80 .6 1981-90 .6 1981-90 1991-2000 1991-2000 .8 2001-06 .8 2001-06 1 1 International Reserves/GDP International Reserves/GDP Center is at 0 Center is at 0 Latin America Developing Asia Monetary Independence Monetary Independence Financial Integration Exchange Rate Stability Financial Integration Exchange Rate Stability .2 .2 .4 1971-80 .4 1971-80 .6 1981-90 .6 1981-90 1991-2000 1991-2000 .8 2001-06 .8 2001-06 1 1 International Reserves/GDP International Reserves/GDP Center is at 0 Center is at 0 Emerging Latin America Emerging Asian Economies Monetary Independence Monetary Independence Financial Integration Exchange Rate Stability Financial Integration Exchange Rate Stability .2 .2 .4 1971-80 .4 1971-80 .6 1981-90 .6 1981-90 1991-2000 1991-2000 .8 2001-06 .8 2001-06 1 1 International Reserves/GDP International Reserves/GDP Center is at 0 Note: This sample includes Taiwan, HK, Indonesia, Korea, Malaysia, Philipines, Singapore, Thailand, China NOTES: “Emerging Asian Economies” include China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. “Emerging Latin America” includes Argentina, Brazil, Chile, Colombia, Ecuador, Jamaica, Mexico, Peru, Trinidad and Tobago, and Venezuela. Source: Aizenman, Chinn, and Ito, “The Emerging Global Financial Architecture,” mimeo (March 2009). 1.0 0.9 LDC cait = ρ + ρ −110 + vca itit LDCex.-oil 0.8 0.7 0.6 0.5 0.4 0.3 Float Dirty Float Dirty Float/ Fixed Crawling Peg AR1 coefficients for CA/GDP 1.0 0.9 LDC LDCex.-oil 0.8 0.7 0.6 0.5 0.4 0.3 Float Dirty Float Dirty Float/ Fixed Crawling Peg AR1 coefficients for CA/GDP, with openness as covariate 1.0 0.9 0.8 0.7 LDC LDC ex.-oil 0.6 0.5 0.4 0.3 Float Dirty Float Dirty Float/ Fixed Crawling Peg AR1 coefficients for real effective exchange rate, with openness as covariate Source: Chinn and Wei, “A Faith-based Initiative: Do We Really Know that a Flexible Exchange Rate Regime Facilitates Current Account Adjustment?” mimeo (March 2009). Pa854_trilemma_s13 .
Load more

Recommended publications
  • China's Economic Liberalisation and the Impossible Trinity
    Bachelor’s Thesis China’s Economic Liberalisation and the Impossible Trinity Zurich University of Applied Sciences School of Management and Law BSc in International Management Max A. Dörrer Matriculation Number: 17-680-653 Zürich Submitted to Dr. Markus Braun Winterthur, 27 May 2020 Management Summary China’s global economic and political ascent, as well as its unique mix of state control and free market principles, has been unprecedented and attracted foreign interest as well as criticism to its economic system. Although China pledged towards increasing economic openness, its progress is ambiguous and difficult to assess. Due to China’s economic power, it is necessary to understand and evaluate its macroeconomic policy- making in order to analyse its strengths and weaknesses, as well as to predict future developments. The main objective of this thesis was to research China’s policy stance and its relationship in line with the Impossible Trinity, and to outline the respective reforms in regard to the country’s capital accounts, exchange rate regime and monetary sovereignty. Moreover, this thesis aimed to evaluate if the model of the Impossible Trinity can be applied to China and lastly, to evaluate potential areas of future reforms. A literature review and expert interviews were conducted to answer the aforementioned objectives. The literature review elucidated the liberalisation reforms and the Impossible Trinity, and its particular applicability to China. The expert interviews supported a holistic interpretation of the results and provided insights into potential future liberalisation steps. In particular, China measurably decreased its exchange rate control through wider trading bandwidths and market-based pricing mechanisms.
    [Show full text]
  • The Political-Economy Trilemma
    DPRIETI Discussion Paper Series 20-E-018 The Political-Economy Trilemma AIZENMAN, Joshua University of Southern California and NBER ITO, Hiroyuki RIETI The Research Institute of Economy, Trade and Industry https://www.rieti.go.jp/en/ RIETI Discussion Paper Series 20-E-018 March 2020 The Political-Economy Trilemma1 Joshua Aizenman University of Southern California and NBER Hiro Ito Portland State University Research Institute of Economy, Trade and Industry Abstract This paper investigates the political-economy trilemma: policy makers face a trade-off of choosing two out of three policy goals or governance styles, namely, (hyper-)globalization, national sovereignty, and democracy. We develop a set of indexes that measure the extent of attainment of the three factors for 139 countries in the period of 1975-2016. Using these indexes, we examine the validity of the hypothesis of the political-economy trilemma by testing whether the three trilemma variables are linearly related. We find that, for industrialized countries, there is a linear relationship between globalization and national sovereignty (i.e., a dilemma), and that for developing countries, all three indexes are linearly correlated (i.e., a trilemma). We also investigate whether and how three political-economic factors affect the degree of political and financial stability. The results indicate that more democratic industrialized countries tend to experience more political instability, while developing countries tend to be able to stabilize their politics if they are more democratic. The lower level of national sovereignty an industrialized country attains, the more stable its political situation tends to be, while a higher level of sovereignty helps a developing country to stabilize its politics.
    [Show full text]
  • API-119: Advanced Macroeconomics for the Open Economy I, Fall 2020
    Sep 1, 2020 API-119: Advanced Macroeconomics for the Open Economy I, Fall 2020 Harvard Kennedy School Course Syllabus: prospectus, outline/schedule and readings Staff: Professor: Jeffrey Frankel [email protected] Faculty Assistant: Minoo Ghoreishi [email protected] Teaching Fellow: Can Soylu Course Assistants: Julio Flores, Alberto Huitron & Yi Yang. Email address to send all questions for the teaching team: [email protected]. Times: Lectures: Tuesdays and Thursdays, 10:30-11:45 a.m. EST.1 Review Sessions: Tuesdays, 12:30-1:30 pm; Fridays, 1:30-2:30 pm EST.2 Final exam: Friday, Dec. 11, 8:00-11:00 am EST. Prospectus Course Description: This course is the first in the two-course sequence on Macroeconomic Policy in the MPA/ID program. It particularly emphasiZes the international dimension. The general perspective is that of developing countries and other small open economies, defined as those for whom world income, world inflation and world interest rates can be taken as given, and possibly the terms of trade as well. The focus is on monetary, fiscal, and exchange rate policy, and on the determination of the current account balance, national income, and inflation. Models of devaluation include one that focuses on the price of internationally traded goods relative to non-traded goods. A theme is the implications of increased integration of global financial markets. Another is countries’ choice of monetary regime, especially the degree of exchange rate flexibility. Applications include Emerging Market crises and problems of commodity-exporting countries. (Such topics as exchange rate overshooting, speculative attacks, portfolio diversification and debt crises will be covered in the first half of Macro II in February-March.) Nature of the approach: The course is largely built around analytical models.
    [Show full text]
  • Argentina's Monetary and Exchange Rate Policies After the Convertibility
    CENTER FOR ECONOMIC AND POLICY RESEARCH April Argentina’s Monetary and Exchange Rate Policies after the Convertibility Regime Collapse • ii Contents Introduction 1 1. The Convertibility Regime 2 2. The Post-Convertibility Macroeconomic Regime and Performance 9 2.1 The Main Characteristics of the Economic Recovery 10 2.2 The Evolution of Monetary and Exchange Rate Policies 16 3. A Macroeconomic Policy Regime with a SCRER as an Intermediate Target 25 3.1 The Orthodox Arguments Against RER Targeting 26 3.2 The Exchange Rate Policy 29 3.3 The Exchange Market and Capital Flows 30 3.4 Monetary Policy 31 Conclusion 35 References 36 Chronological Appendix 39 About the Authors Roberto Frenkel is a senior research associate at the Center for Economic and Policy Research in Washington, D.C. and Principal Research Associate at the Centro de Estudios de Estado y Sociedad (CEDES) in Buenos Aires, Argentina. Martín Rapetti is a research assistant at CEDES and a Ph.D. candidate at the University of Massachusetts, Amherst. Acknowledgements This paper was written as part of an international research project on Alternatives to Inflation Targeting for Stable and Equitable Growth co-directed by Gerald Epstein, PERI and Erinc Yeldan, Bilkent University. The authors thank the Rockefeller Brothers Fund, Ford Foundation and UN-DESA for financial support. Additionally, Nelson Barbosa-Filho, Erinc Yeldan and the participants in the workshop on “Alternatives to Inflation Targeting Monetary Policy for Stable and Egalitarian Growth in Developing Countries” held at CEDES in May 13-14, 2005 contributed comments to a previous version of this paper. Finally, the authors thank Julia Frenkel for her collaboration and Erinc Yeldan and an anonymous referee from World Development for their comments and suggestions.
    [Show full text]
  • Cryptocurrencies, Currency Competition, and the Impossible Trinity
    NBER WORKING PAPER SERIES CRYPTOCURRENCIES, CURRENCY COMPETITION, AND THE IMPOSSIBLE TRINITY Pierpaolo Benigno Linda M. Schilling Harald Uhlig Working Paper 26214 http://www.nber.org/papers/w26214 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 August 2019 Linda Schilling's work was conducted in the framework of the Chair 'Blockchain and B2B Platforms' at Ecole Polytechnique. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2019 by Pierpaolo Benigno, Linda M. Schilling, and Harald Uhlig. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. Cryptocurrencies, Currency Competition, and the Impossible Trinity Pierpaolo Benigno, Linda M. Schilling, and Harald Uhlig NBER Working Paper No. 26214 August 2019 JEL No. D53,E4,F31,G12 ABSTRACT We analyze a two-country economy with complete markets, featuring two national currencies as well as a global (crypto)currency. If the global currency is used in both countries, the national nominal interest rates must be equal and the exchange rate between the national currencies is a risk- adjusted martingale. We call this result Crypto-Enforced Monetary Policy Synchronization (CEMPS). Deviating from interest equality risks approaching the zero lower bound or the abandonment of the national currency.
    [Show full text]
  • The Impossible Trinity: Inflation Targeting, Exchange Rate Management and Open Capital Accounts in Emerging Economies
    This is a repository copy of The Impossible Trinity: Inflation Targeting, Exchange Rate Management and Open Capital Accounts in Emerging Economies. White Rose Research Online URL for this paper: http://eprints.whiterose.ac.uk/104403/ Version: Accepted Version Article: Kaltenbrunner, A orcid.org/0000-0003-3519-5197 and Painceira, JP (2017) The Impossible Trinity: Inflation Targeting, Exchange Rate Management and Open Capital Accounts in Emerging Economies. Development and Change, 48 (3). pp. 452-480. ISSN 0012-155X https://doi.org/10.1111/dech.12304 © 2017 International Institute of Social Studies. This is the peer reviewed version of the following article: Kaltenbrunner, A. and Painceira, J. P. (2017), The Impossible Trinity: Inflation Targeting, Exchange Rate Management and Open Capital Accounts in Emerging Economies. Development and Change, 48: 452–480. doi:10.1111/dech.12304; which has been published in final form at https://doi.org/10.1111/dech.12304. This article may be used for non-commercial purposes in accordance with the Wiley Terms and Conditions for Self-Archiving. Reuse Items deposited in White Rose Research Online are protected by copyright, with all rights reserved unless indicated otherwise. They may be downloaded and/or printed for private study, or other acts as permitted by national copyright laws. The publisher or other rights holders may allow further reproduction and re-use of the full text version. This is indicated by the licence information on the White Rose Research Online record for the item. Takedown If you consider content in White Rose Research Online to be in breach of UK law, please notify us by emailing [email protected] including the URL of the record and the reason for the withdrawal request.
    [Show full text]
  • The Return of Capital Controls?
    YIANNI & DE VERA 1/16/2011 THE RETURN OF CAPITAL CONTROLS? ANDREW YIANNI* CARLOS DE VERA** I INTRODUCTION One of the consequences of the global financial crisis is that advanced economies, such as the United States and United Kingdom, currently have very loose monetary policies with very low interest rates. A number of the stronger economies in the emerging markets—China, India, and Brazil, for example— have suffered less than many industrial countries. Not surprisingly, therefore, there has been a tendency for capital to flow to certain emerging markets in search of higher returns. Emerging-market economies with freely floating (or close to freely floating) exchange-rate regimes, open capital accounts, and solid fundamentals, have seen their currency appreciate as a consequence, as Brazil did in 2009. Clearly, this economic consequence creates a policy challenge for the affected emerging markets. If the decision is made to allow the currency to appreciate, exports will become relatively more expensive and imports relatively less expensive. This policy will have an adverse effect on domestic employment and will move the current account towards deficit (or into greater deficit). Such a policy could also make the system vulnerable to a future shock if the capital inflows were subsequently rapidly reversed. In this environment, there will be a tendency for those in the affected emerging markets to consider a range of measures, including implementing capital controls to slow down or ration the inflow of capital. Clearly, any such step would run counter to the trend towards liberalization of capital movements specifically and globalization generally. The global financial crisis has also brought capital controls back into focus as a means of responding to a crisis.
    [Show full text]
  • “Impossible Trinity”: Towards a Mix of Macroeconomic Policy Instruments for Sustaining Economic Development in Brazil
    Brazilian Journal of Political Economy, vol 31, nº 5 (125), pp 912-927, Special edition 2011 Overcoming the “impossible trinity”: towards a mix of macroeconomic policy instruments for sustaining economic development in Brazil ANDRÉ NASSIF* Although there have been more than twelve years since high inflation was elim‑ inated and a floating exchange rate regime was introduced in Brazil in 1999, at least two aspects have clearly marked the Brazilian economy in the 1999‑2011 period: first, business cycles were characterised by stop and go behaviour, with annual aver‑ age growth rates of real GDP (3.4%) much lower than the emerging and developing countries (6.0%) and very close to the global economy (3.7% — see Figure 1); and second, there was a cyclical and persistent tendency of the Brazilian currency to ap‑ preciate in real terms (Nassif, Feijó and Araújo, 2011). As well discussed by many studies1, a significant part of this poor performance can be credited, on the one hand, to the Brazilian growth model based on external saving through which growing and unsustainable current account deficits are gen‑ erally reversed by overshooting of the nominal and real exchange rates and sudden stops. And on the other hand, to a very narrow and orthodox short‑term macro‑ economic policy which has over‑pursued the goals of price stability and monetary independence compared with other equally important economic and social goals, such as a sustainable long‑term growth; structural change directed to both diver‑ sify exports to sectors of higher technological intensity and prevent the economy * Fluminense Federal University (Universidade Federal Fluminense) and The Brazilian Development Bank (BNDES), Brazil.
    [Show full text]
  • Capital Inflows and the Impossible Trinity in China
    Jian, Shaoyi and Yanzhi, Journal of International and Global Economic Studies, 4(2), December 2011, 30-46 30 Capital Inflows and the Impossible Trinity in China Han Jian, Cheng Shaoyi and Shen Yanzhi* Nanjing University, Nanjing The Johns Hopkins University - Nanjing University Center, Nanjing Abstract: In this paper, we estimate China’s capital market openness in de facto measure, and compare it with that in de jure measure. Although in recent decade China’s capital market openness remained stable in de jure measurement, it has increased substantially in de facto sense. Large capital inflows have forced China into facing increasing dilemma of achieving monetary independence and exchange rate stability. We outline metrics for measuring the Impossible Trinity aspects: exchange rate stability, monetary independence, and capital market openness, taking into consideration of sterilization. China’s authorities have taken on open market operations and reserve requirement ratio as sterilization tools to retain some degree of monetary autonomy, but they are costly and unsustainable. We also test the linearity of the Impossible Trinity, and find that the weighted sum of the three trilemma variables adds up to a constant, indicating China meets the Trilemma. Thus, we suggest that exchange rate flexibility and appropriate capital controls should be taken in the future, considering further growing capital inflows and domestic inflationary pressures. Keywords: capital inflows, capital market openness, the Impossible Trinity, Trilemma, sterilization JEL classification: E22, F32, F36, F41 1. Introduction Over the last 30 years, a rapid growth of cross-border capital flows has become a prominent feature in an increasingly globalized economy. In the meantime, however, these flows also experienced unprecedented volatility in recent years.
    [Show full text]
  • The Impossible Trinity: Where Does India Stand?
    WP-2015-05 The Impossible Trinity: Where does India stand? Rajeswari Sengupta Indira Gandhi Institute of Development Research, Mumbai March 2015 http://www.igidr.ac.in/pdf/publication/WP-2015-05.pdf The Impossible Trinity: Where does India stand? Rajeswari Sengupta Indira Gandhi Institute of Development Research (IGIDR) General Arun Kumar Vaidya Marg Goregaon (E), Mumbai- 400065, INDIA Email(corresponding author): [email protected] Abstract The Global Financial Crisis of 2008 and the heightened macroeconomic and financial volatility that followed the crisis raised important questions about the current international financial architecture as well as about individual countries' external macroeconomic policies. Policy- makers dealing with the global crisis have been confronted with the 'impossible trinity' or the 'Trilemma', a potent paradigm of open economy macroeconomics asserting that a country may not target the exchange rate, conduct an independent monetary policy and have full financial integration, all at the same time. This issue is highly pertinent for India. A number of challenges have emanated from India's greater integration with the global financial markets during the last two decades, one of which includes managing the policy tradeoffs under the Trilemma. In this chapter, I present a comprehensive overview of a few empirical studies that have explored the issue of Trilemma in the Indian context. Based on these studies I attempt to analyze how have Indian policy makers dealt with the various trade-offs while managing the Trilemma over the last two decades. Keywords: Impossible Trinity, Financial Integration, Currency Stabilization, International Reserves, Sterilized Intervention JEL Code: F3, F4, F6 Acknowledgements: Views expressed here are entirely my own and do not reflect that of my co-authors with whom I have written the papers that have been surveyed here.
    [Show full text]
  • Joshua Aizenman*
    Forthcoming, Economic Modelling March 2018 A modern reincarnation of Mundell-Fleming's Trilemma Joshua Aizenman* USC and the NBER Abstract A modern incarnation of the trilemma is essential for understanding the evolving global financial architecture, and for coming up with ways to mitigate financial fragility. The scarcity of policy instruments relative to the policy goals implies complex country-specific tradeoffs between the policy goals. The financial crises of the 1990s induced Emerging markets to converge to trilemma’s middle ground -- managed exchange-rate flexibility, controlled financial integration, and viable but limited monetary independence. Capital flight crises added financial stability to trilemma’s policy goals. New policies were added to deal with financial fragility associated with financial integration, including precautionary management of international reserves by emerging markets, swap lines among OECD’s central banks, and macroeconomic prudential regulations. These trade-offs are impacted by a country’s balance sheet exposure to hard currencies, the exchange-rate regime, and the growing sensitivity to shocks emanating from the U.S. and the Eurozone in the aftermath of the Global Financial Crisis. Keywords: The impossible trinity, international reserves, financial crises, financial stability, swap lines, debt and banking crises, balance sheet exposure. Highlights: Emerging markets converged to the trilemma’s middle ground following financial crises Financial stability was added to the original trilemma policy goals New policy instruments were added to deal with financial stability The added instruments included macro-prudential, managing buffers, and swap lines Developed and emerging countries use a different mixture of policy instruments JEL Classification: F 31, F 32, F33, F34, F36, F38 * This paper extends a keynote address at the INFER Conference, June 2017, Bordeaux.
    [Show full text]
  • China's Balancing
    January 2016 Report China’s balancing act Why the internationalisation of the renminbi matters for the global economy Phyllis Papadavid • With an estimated $4 trillion in foreign exchange reserves, China’s liberalisation, and that of its Key currency, the Renminbi (RMB), matters. messages • China’s liberalisation will bring further financial market volatility as it manages an economic slowdown and financial sector deepening. • Foreign capital flows will introduce a ‘hard’ budget constraint for unprofitable banks and corporations. • The effects of increases in trade and investment after full RMB internationalisation could offset the global trade slowdown. • Past liberalisations have, more often than not, heralded currency crises; given this, China’s policy-makers will reform at a slow, steady pace. • China’s contribution to world trade and investment could help mitigate emerging and developing economies’ ‘triple crises’ of higher US interest rates, lower oil prices and its own growth transition. Shaping policy for development odi.org Contents Abbreviations 4 Executive summary 5 1.China could see financial volatility rise further 6 1.1 Further financial volatility 6 1.2 China’s evolving financial liberalization 8 1.3 PBOC currency policy 9 2. RMB internationalisation, a global growth boon? 10 2.1 RMB offshore centres a key catalyst 10 2.2 RMB’s transactional usage is rising 11 2.3 China’s catalytic investments 12 3. China’s objective – a tripolar currency world 13 4. Conclusions 14 References 15 2 ODI Report List of figures and boxes Figures Figure A. Key pathways and transmission mechanisms for RMB internationalisation 5 Figure 1. China’s consumption share (% GDP) 6 Figure 2.
    [Show full text]