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Trilemma Policy Convergence Patterns and Output Volatility

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  • Joshua Aizenman

    (University of California, Santa Cruz and National Bureau of Economic Research and Hong Kong Institute for Monetary Research)

  • Hiro Ito

    (Portland State University)

Abstract

We examine the development of open macroeconomic policy choices among developing economies from the perspective of the powerful "trilemma" hypothesis. We construct an index of divergence of the three trilemma policy choices, and evaluate its patterns in recent decades. We find that the three dimensions of the trilemma configurations are converging towards a "middle ground" among emerging market economies, equipped with managed exchange rate flexibility, underpinned by sizable holdings of international reserves, and intermediate levels of monetary independence and financial integration. We also find emerging market economies with more converged policy choices tend to experience smaller output volatility in the last two decades. Emerging markets with relatively low international reserves/GDP could experience higher levels of output volatility when they choose a policy combination with a greater degree of policy divergence while this heightened output volatility effect does not apply to economies with relatively high international reserves/GDP holding.

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Bibliographic Info

Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 112012.

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Length: 29 pages
Date of creation: Apr 2012
Date of revision:
Handle: RePEc:hkm:wpaper:112012

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Keywords: Impossible Trinity; International Reserves; Financial Liberalization; Exchange Rate Regime;

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References

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  1. Joshua Aizenman & Nancy P. Marion, 2002. "International Reserve Holdings with Sovereign Risk and Costly Tax Collection," NBER Working Papers 9154, National Bureau of Economic Research, Inc.
  2. Joshua Aizenman & Jaewoo Lee, 2005. "International Reserves: Precautionary versus Mercantilist Views, Theory and Evidence," NBER Working Papers 11366, National Bureau of Economic Research, Inc.
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  7. Maurice Obstfeld & Jay C.Shambaugh & Alan M.Taylor, 2003. "The Trilemma in History:Tradeoffs among Exchange Rates, Monetary Policies,and Capital Mobility," DNB Staff Reports (discontinued) 94, Netherlands Central Bank.
  8. Obstfeld, Maurice & Shambaugh, Jay C & Taylor, Alan M, 2008. "Financial Stability, the Trilemma, and International Reserves," CEPR Discussion Papers 6693, C.E.P.R. Discussion Papers.
  9. Eswar S. Prasad & Raghuram Rajan, 2008. "A Pragmatic Approach to Capital Account Liberalization," NBER Working Papers 14051, National Bureau of Economic Research, Inc.
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  22. Aizenman, Joshua & Chinn, Menzie David & Ito, Hiro, 2009. "Assessing the Emerging Global Financial Architecture: Measuring the Trilemma's Configurations over Time," Santa Cruz Department of Economics, Working Paper Series qt840728sc, Department of Economics, UC Santa Cruz.
  23. Aizenman, Joshua, 2011. "The Impossible Trinity – from the Policy Trilemma to the Policy Quadrilemma," Santa Cruz Department of Economics, Working Paper Series qt8cq7g4c9, Department of Economics, UC Santa Cruz.
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Citations

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Cited by:
  1. Jamilov, Rustam, 2012. "Capital mobility in the Caucasus," MPRA Paper 38184, University Library of Munich, Germany, revised Apr 2012.
  2. Joshua Aizenman & Hiro Ito, 2013. "Living with the Trilemma Constraint: Relative Trilemma Policy Divergence, Crises, and Output Losses for Developing Countries," NBER Working Papers 19448, National Bureau of Economic Research, Inc.
  3. Bonatti, Luigi & Fracasso, Andrea, 2013. "Hoarding of international reserves in China: Mercantilism, domestic consumption and US monetary policy," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 1044-1078.
  4. Yu Hsing, 2012. "Impacts of the Trilemma Policies on Inflation, Growth and Volatility in Greece," International Journal of Economics and Financial Issues, Econjournals, vol. 2(3), pages 373-378.
  5. Jean Pierre Allegret, 2012. "Responses of Monetary Authorities in Emerging Economies to International Financial Crises: What Do We Really know?," European Research Studies Journal, European Research Studies Journal, vol. 0(3), pages 3-32.
  6. Rustam Jamilov, 2013. "J-Curve Dynamics and the Marshall–Lerner Condition: Evidence from Azerbaijan," Transition Studies Review, Springer, vol. 19(3), pages 313-323, February.

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