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The Impossible Trinity – from the Policy Trilemma to the Policy Quadrilemma

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  • Aizenman, Joshua

Abstract

The policy Trilemma (the ability to accomplish only two policy objectives out of financialintegration, exchange rate stability and monetary autonomy) remains a valid macroeconomicframework. The financial globalization during 1990s-2000s reduced the weighted average ofexchange rate stability and monetary autonomy. An unintended consequence of financialglobalization is the growing exposure of developing countries to capital flights, and deleveragingcrises. The significant costs associated with these crises added financial stability to the Trilemmapolicy goals, modifying the Trilemma framework into the policy Quadrilemma. Emergingmarkets frequently coupled their growing financial integration with sizable hoarding of reserves,as means of self-insuring their growing exposure to financial turbulences. The global financialcrisis of 2008-9 illustrated both the usefulness and the limitations of hoarding reserves as a selfinsurancemechanism. The massive deleveraging initiated by OECD countries in 2008 mayprovide the impetus for some emerging markets to impose “soft capital controls,†in the form ofregulations that restrain inflows of short terms funds. While modifying the global financialarchitecture to deal with the challenges of the 21th Centaury remains a work in progress, theextended Trilemma framework keeps providing useful insights about the trade-offs andchallenges facing policy makers, investors, and central banks.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt8cq7g4c9.

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Date of creation: 28 Mar 2011
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Handle: RePEc:cdl:ucscec:qt8cq7g4c9

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Keywords: Social and Behavioral Sciences;

References

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  1. Maurice Obstfeld & Jay C. Shambaugh & Alan M. Taylor, 2004. "Monetary Sovereignty, Exchange Rates, and Capital Controls: The Trilemma in the Interwar Period," IMF Staff Papers, Palgrave Macmillan, Palgrave Macmillan, vol. 51(s1), pages 75-108, June.
  2. Joshua Aizenman & Nancy P. Marion, 2002. "The high demand for international reserves in the Far East: what's going on?," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Sep.
  3. Jeffrey A. Frankel & Sergio L. Schmukler & Luis Serven, 2002. "Global Transmission of Interest Rates: Monetary Independence and Currency Regime," NBER Working Papers, National Bureau of Economic Research, Inc 8828, National Bureau of Economic Research, Inc.
  4. Joshua Aizenman & Jaewoo Lee, 2005. "International reserves: precautionary versus mercantilist views, theory and evidence," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco.
  5. Maurice Obstfeld & Kenneth Rogoff, 1995. "The Mirage of Fixed Exchange Rates," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 9(4), pages 73-96, Fall.
  6. Olivier Jeanne, 2007. "International Reserves in Emerging Market Countries: Too Much of a Good Thing?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, Economic Studies Program, The Brookings Institution, vol. 38(1), pages 1-80.
  7. Aizenman, Joshua & Chinn, Menzie D. & Ito, Hiro, 2010. "The emerging global financial architecture: Tracing and evaluating new patterns of the trilemma configuration," Journal of International Money and Finance, Elsevier, Elsevier, vol. 29(4), pages 615-641, June.
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Cited by:
  1. Pablo Pincheira, 2013. "Interventions and Inflation Expectations in an Inflation Targeting Economy," Working Papers Central Bank of Chile, Central Bank of Chile 693, Central Bank of Chile.
  2. Joshua Aizenman & Hiro Ito, 2012. "Trilemma Policy Convergence Patterns and Output Volatility," NBER Working Papers, National Bureau of Economic Research, Inc 17806, National Bureau of Economic Research, Inc.
  3. Giancarlo Marini & Giovanni Piersanti, 2012. "Models of Speculative Attacks and Crashes in International Capital Markets," CEIS Research Paper, Tor Vergata University, CEIS 245, Tor Vergata University, CEIS, revised 24 Jul 2012.

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