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New Measures of the Trilemma Hypothesis : Implications for Asia

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  • Hiro Ito

    (Asian Development Bank Institute (ADBI))

  • Masahiro Kawai

Abstract

We develop a new set of indexes of exchange rate stability, monetary policy independence, and financial market openness as the metrics for the trilemma hypothesis. In our exploration, we take a different and more nuanced approach than the previous indexes developed by Aizenman, Chinn, and Ito (2008). We show that the new indexes add up to the value two, supporting the trilemma hypothesis. We locate our sample economies’ policy mixes in the famous trilemma triangle—a useful and intuitive way to illustrate the state and evolution of policy mixes. We also examine if the persistent deviation of the sum of the three indexes from the value two indicates an unsustainable policy mix and therefore needs to be corrected by economic disruptions such as economic and financial crises. We obtain several findings. First, such a persistent deviation can occur particularly in emerging economies that later experience an inflation (or potentially a general or a currency) crisis, and dissipates in the postcrisis period. Second, there is no evidence for this type of association between deviations from the trilemma constraint and general, banking, or debt crises. Third, Thailand experienced such a deviation from the trilemma constraint in the period leading to the baht crisis of 1997, but not other East and Southeast Asian economies. This last result suggests that the main cause for the Thai baht crisis was an unsustainable policy mix in the precrisis period, while other affected economies experienced crises mainly due to contagion from Thailand.

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Bibliographic Info

Paper provided by East Asian Bureau of Economic Research in its series Finance Working Papers with number 23331.

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Date of creation: Sep 2012
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Handle: RePEc:eab:financ:23331

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Keywords: exchange rate stability; monetary policy independence; financial market openness; the trilemma hypothesis; emerging economies; Southeast Asian; Thailand;

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  1. Obstfeld, Maurice & Shambaugh, Jay C & Taylor, Alan M, 2004. "The Trilemma in History: Trade-offs Among Exchange Rates, Monetary Policies and Capital Mobility," CEPR Discussion Papers 4352, C.E.P.R. Discussion Papers.
  2. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2007. "The external wealth of nations mark II: Revised and extended estimates of foreign assets and liabilities, 1970-2004," Journal of International Economics, Elsevier, vol. 73(2), pages 223-250, November.
  3. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 1999. "The External Wealth of Nations: Measures of Foreign Assets and Liabilities for Industrial and Developing Countries," CEPR Discussion Papers 2231, C.E.P.R. Discussion Papers.
  4. Garcia, R. & Perron, P., 1994. "An Analysis of the Real Interest rate Under Regime Shifts," Cahiers de recherche 9428, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  5. Kawai, Masahiro & Akiyama, Shigeru, 1998. "The Role of Nominal Anchor Currencies in Exchange Rate Arrangements," Journal of the Japanese and International Economies, Elsevier, vol. 12(4), pages 334-387, December.
  6. John Huizinga & Frederic S. Mishkin, 1985. "Inflation and Real Interest Rates on Assets with Different Risk Characteristics," NBER Working Papers 1333, National Bureau of Economic Research, Inc.
  7. Chinn, Menzie David & Ito, Hiro, 2005. "What Matters for Financial Development? Capital Controls, Institutions, and Interactions," Santa Cruz Center for International Economics, Working Paper Series qt5pv1j341, Center for International Economics, UC Santa Cruz.
  8. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  9. Dennis Quinn & Martin Schindler & A Maria Toyoda, 2011. "Assessing Measures of Financial Openness and Integration," IMF Economic Review, Palgrave Macmillan, vol. 59(3), pages 488-522, August.
  10. Eichengreen, Barry & Rose, Andrew & Wyplosz, Charles, 1996. " Contagious Currency Crises: First Tests," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(4), pages 463-84, December.
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Cited by:
  1. Ito, Hiro & Kawai, Masahiro, 2014. "Determinants of the Trilemma Policy Combination," ADBI Working Papers 456, Asian Development Bank Institute.
  2. Kawai, Masahiro & Pontines, Victor, 2014. "The Renminbi and Exchange Rate Regimes in East Asia," ADBI Working Papers 484, Asian Development Bank Institute.

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