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The financial trilemma in China and a comparative analysis with India

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  • Aizenman, Joshua
  • Sengupta, Rajeswari

Abstract

A key challenge facing most emerging market economies today is how to simultaneously maintain monetary independence, exchange rate stability and financial integration subject to the constraints imposed by the Trilemma, in the era of deepening globalization. In this paper we study the Trilemma choices of the two key drivers of global growth, China and India. We overview and contrast the policy choices of the two, and test their Trilemma choices and tradeoffs. China’s Trilemma configurations are unique relative to the one characterizing other emerging markets in the predominance of exchange rate stability, and in the failure of the Trilemma regression to capture any significant role for financial integration. One possible interpretation is that the segmentation of the domestic capital market in China, its array of capital controls and the large hoarding of international reserves imply that the “policy interest rate” does not reflect the stance of monetary policy. In contrast, the Trilemma configurations of India are in line with the regression results of other emerging countries, and are consistent with the predictions of the Trilemma tradeoffs. India like other emerging economies has overtime converged towards a middle ground between the three policy objectives, and has achieved comparable levels of exchange rate stability and financial integration buffered by sizeable international reserves.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 34485.

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Date of creation: 01 Nov 2011
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Handle: RePEc:pra:mprapa:34485

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Keywords: Financial trilemma; International reserves; Foreign exchange intervention; Monetary policy; Capital account openness;

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  1. Aizenman, Joshua & Chinn, Menzie & Ito, Hiro, 2010. "The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma," ADBI Working Papers 213, Asian Development Bank Institute.
  2. Shah, Ajay, 2008. "New issues in Indian macro policy," Working Papers 08/51, National Institute of Public Finance and Policy.
  3. Sebastian Edwards & Eduardo Levy Yeyati, 2003. "Flexible Exchange Rates as Shock Absorbers," NBER Working Papers 9867, National Bureau of Economic Research, Inc.
  4. 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.
  5. Michael Hutchison & Jake Kendall & Gurnain Pasricha & Nirvikar Singh, 2009. "Indian Capital Control Liberalization : Evidence from NDF Markets," Finance Working Papers 22971, East Asian Bureau of Economic Research.
  6. Reuven Glick & Michael Hutchison, 2008. "Navigating the Trilemma: Capital Flows and Monetary Policy in China," Working Papers 252008, Hong Kong Institute for Monetary Research.
  7. Joshua Aizenman & Reuven Glick, 2009. "Sterilization, Monetary Policy, and Global Financial Integration," Review of International Economics, Wiley Blackwell, vol. 17(4), pages 777-801, 09.
  8. Ajay Shah & Ila Patnaik & Anmol Sethy & Vimal Balasubramaniam, 2010. "The Exchange Rate Regime in Asia: From Crisis to Crisis," Working Papers id:2582, eSocialSciences.
  9. Joshua Aizenman & Menzie D. Chinn & Hiro Ito, 2010. "Surfing the Waves of Globalization: Asia and Financial Globalization in the Context of the Trilemma," NBER Working Papers 15876, National Bureau of Economic Research, Inc.
  10. ChangJin Kim & Jong-Wha Lee, 2008. "Exchange Rate Regime And Monetary Policy Independence In East Asia," Pacific Economic Review, Wiley Blackwell, vol. 13(2), pages 155-170, 05.
  11. Michael Hutchison & Rajeswari Sengupta & Nirvikar Singh, 2012. "India’s Trilemma: Financial Liberalisation, Exchange Rates and Monetary Policy," The World Economy, Wiley Blackwell, vol. 35(1), pages 3-18, 01.
  12. R. Kohli, 2012. "India’s Experience in Navigating the Trilemma : Do Capital Controls Help?," Governance Working Papers 23184, East Asian Bureau of Economic Research.
  13. Prema-chandra Athukorala, 2009. "Outward Direct Investment from India," Departmental Working Papers 2009-14, The Australian National University, Arndt-Corden Department of Economics.
  14. Vladimir Sokolov & Byung‐Joo Lee & Nelson C. Mark, 2011. "Linkages Between Exchange Rate Policy And Macroeconomic Performance," Pacific Economic Review, Wiley Blackwell, vol. 16(4), pages 395-420, October.
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Cited by:
  1. Guonan Ma & Robert N McCauley, 2013. "Is China or India more financially open?," BIS Working Papers 410, Bank for International Settlements.
  2. Herrala, Risto & Cheung, Yin-Wong, 2013. "China’s capital controls – Through the prism of covered interest differentials," BOFIT Discussion Papers 22/2013, Bank of Finland, Institute for Economies in Transition.
  3. Yu HSING, 2012. "Effects of the Trilemma Policies on Inflation, Growth and Volatility in Bulgaria," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania - AGER, vol. 0(4(569)), pages 49-58, April.
  4. Sen Gupta, Abhijit & Sengupta, Rajeswari, 2013. "Management of Capital Flows in India: 1990-2011," MPRA Paper 46217, University Library of Munich, Germany.
  5. Marcelo Bianconi & Joe A. Yoshino & Mariana O. Machado de Sousa, 2011. "BRIC and the U.S. Financial Crisis: An Empirical Investigation of Stocks and Bonds Markets," Discussion Papers Series, Department of Economics, Tufts University 0764, Department of Economics, Tufts University.
  6. 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.

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