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Rounding the Corners of the Policy Trilemma: Sources of Monetary Policy Autonomy

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  • Michael W. Klein

    (Fletcher School, Tufts University, and NBER (E-mail: michael.klein@tufts.edu))

  • Jay C. Shambaugh

    (George Washington University and NBER (E-mail: jshambaugh@gwu.edu))

Abstract

A central result in international macroeconomics is that a government cannot simultaneously opt for open financial markets, fixed exchange rates, and monetary autonomy; rather, it is constrained to choosing no more than two of these three. In the wake of the Great Recession, however, there has been an effort to address macroeconomic challenges through intermediate measures, such as narrowly targeted capital controls or limited exchange rate flexibility. This paper addresses the question of whether these intermediate policies, which round the corners of the triangle representing the policy trilemma, afford a full measure of monetary policy autonomy. Our results confirm that extensive capital controls or floating exchange rates enable a country to have monetary autonomy, as suggested by the trilemma. Partial capital controls, however, do not generally enable a country to have greater monetary control than is the case with open capital accounts unless they are quite extensive. In contrast, a moderate amount of exchange rate flexibility does allow for some degree of monetary autonomy, especially in emerging and developing economies.

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Bibliographic Info

Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 13-E-14.

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Date of creation: Dec 2013
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Handle: RePEc:ime:imedps:13-e-14

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Keywords: Exchange Rate Regimes; Trilemma; Monetary Policy; Capital Controls;

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  1. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  2. Chinn,M.D. & Ito,H., 2005. "What matters for financial development? : capital controls, institutions, and interactions," Working papers 4, Wisconsin Madison - Social Systems.
  3. Javier Bianchi, 2009. "Overborrowing and systemic externalities in the business cycle," Working Paper 2009-24, Federal Reserve Bank of Atlanta.
  4. Stephanie Schmitt-Grohe & Martin Uribe, 2012. "Prudential Policy for Peggers," NBER Working Papers 18031, National Bureau of Economic Research, Inc.
  5. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
  6. 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.
  7. Jay C. Shambaugh, 2004. "The Effect of Fixed Exchange Rates on Monetary Policy," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 300-351, February.
  8. Emmanuel Farhi & Ivan Werning, 2012. "Dealing with the Trilemma: Optimal Capital Controls with Fixed Exchange Rates," NBER Working Papers 18199, National Bureau of Economic Research, Inc.
  9. Klein, Michael W. & Shambaugh, Jay C., 2006. "Fixed exchange rates and trade," Journal of International Economics, Elsevier, vol. 70(2), pages 359-383, December.
  10. Jacques Miniane & John H. Rogers, 2003. "Capital controls and the international transmission of U.S. money shocks," International Finance Discussion Papers 778, Board of Governors of the Federal Reserve System (U.S.).
  11. Martin Schindler, 2009. "Measuring Financial Integration: A New Data Set," IMF Staff Papers, Palgrave Macmillan, vol. 56(1), pages 222-238, April.
  12. Frankel, Jeffrey & Schmukler, Sergio L. & Serven, Luis, 2004. "Global transmission of interest rates: monetary independence and currency regime," Journal of International Money and Finance, Elsevier, vol. 23(5), pages 701-733, September.
  13. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
  14. Eduardo Levy-Yeyati & Federico Sturzenegger, 2003. "To Float or to Fix: Evidence on the Impact of Exchange Rate Regimes on Growth," American Economic Review, American Economic Association, vol. 93(4), pages 1173-1193, September.
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As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Blogs review: Navigating the open economy trilemma
    by ? in Bruegel blog on 2013-10-01 08:15:34
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Cited by:
  1. Philip Lane, 2013. "International Capital Flows and Domestic Financial Conditions: Lessons for Emerging Asia," The Institute for International Integration Studies Discussion Paper Series iiisdp438, IIIS.

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