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Capital flow volatility regimes and monetary policy dilemma: Evidence from New Zealand

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  • Mansur, Alfan

Abstract

Mundell–Fleming’s trilemma underlines tradeoffs among three things: stable exchange rates, independent monetary policy, and free capital mobility. Rey (2015) finds that the global financial cycle has transformed the “trilemma” into a “dilemma” that constrains monetary policy independence, regardless of the exchange rate regime. Complementary to the existing literature on this framework, we concentrate on the importance of the volatility regimes of capital flows. We estimate a structural Bayesian threshold vector autoregression (TVAR) on New Zealand quarterly data from 1997:I to 2020:IV. Having allowed for different volatility regimes, we find that the “dilemma” will always bind a small open economy like New Zealand. Not only does the amount of capital flow matter, but its volatility also causes substantial impacts. We also find that a contractionary monetary policy shock lowers capital flow volatility, but hinders real GDP growth in the high volatility regime.

Suggested Citation

  • Mansur, Alfan, 2023. "Capital flow volatility regimes and monetary policy dilemma: Evidence from New Zealand," The Journal of Economic Asymmetries, Elsevier, vol. 28(C).
    • Handle: RePEc:eee:joecas:v:28:y:2023:i:c:s1703494923000269
    DOI: 10.1016/j.jeca.2023.e00314
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