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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. 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.
  2. Aizenman, Joshua & Chen, Menzie & Ito, Hiro, 2011. "Surfing the Waves of Globalization: Asia and Financial Globalization in the Context of the Trilemma," Santa Cruz Department of Economics, Working Paper Series qt3897k2ss, Department of Economics, UC Santa Cruz.
  3. 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.
  4. Joshua Aizenman & Menzie D. Chinna & Hiro Ito, 2010. "The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma," Working Papers id:3138, eSocialSciences.
  5. ChangJin Kim & Jong-Wha Lee, 2008. "Exchange Rate Regime And Monetary Policy Independence In East Asia," Pacific Economic Review, Wiley Blackwell, Wiley Blackwell, vol. 13(2), pages 155-170, 05.
  6. Shah, Ajay, 2008. "New issues in Indian macro policy," Working Papers, National Institute of Public Finance and Policy 08/51, National Institute of Public Finance and Policy.
  7. Vladimir Sokolov & Byung‐Joo Lee & Nelson C. Mark, 2011. "Linkages Between Exchange Rate Policy And Macroeconomic Performance," Pacific Economic Review, Wiley Blackwell, Wiley Blackwell, vol. 16(4), pages 395-420, October.
  8. Maurice Obstfeld & Jay C. Shambaugh & Alan M. Taylor, 2010. "Financial Stability, the Trilemma, and International Reserves," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 57-94, April.
  9. Ila Patnaik & Ajay Shah & Anmol Sethy & Vimal Balasubramaniam, 2010. "The exchange rate regime in Asia : From Crisis to Crisis," Finance Working Papers 21852, East Asian Bureau of Economic Research.
  10. Sebastian Edwards & Eduardo Levy Yeyati, 2004. "Flexible Exchange Rates as Shock Absorbers," Business School Working Papers, Universidad Torcuato Di Tella exchangerates, Universidad Torcuato Di Tella.
  11. Joshua Aizenman & Reuven Glick, 2008. "Sterilization, monetary policy, and global financial integration," Working Paper Series, Federal Reserve Bank of San Francisco 2008-15, Federal Reserve Bank of San Francisco.
  12. Glick, Reuven & Hutchison, Michael, 2009. "Navigating the trilemma: Capital flows and monetary policy in China," Journal of Asian Economics, Elsevier, Elsevier, vol. 20(3), pages 205-224, May.
  13. R. Kohli, 2012. "India’s Experience in Navigating the Trilemma : Do Capital Controls Help?," Governance Working Papers 23184, East Asian Bureau of Economic Research.
  14. Prema-chandra Athukorala, 2009. "Outward Direct Investment from India," Departmental Working Papers, The Australian National University, Arndt-Corden Department of Economics 2009-14, The Australian National University, Arndt-Corden Department of Economics.
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Cited by:
  1. 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, Asociatia Generala a Economistilor din Romania - AGER, vol. 0(4(569)), pages 49-58, April.
  2. 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.
  3. Yin-Wong Cheung & Risto Herrala, 2013. "China's Capital Controls - Through the Prism of Covered Interest Differentials," CESifo Working Paper Series 4377, CESifo Group Munich.
  4. Ma, Guonan & McCauley, Robert N., 2013. "Is China or India more financially open?," Journal of International Money and Finance, Elsevier, Elsevier, vol. 39(C), pages 6-27.
  5. Sen Gupta, Abhijit & Sengupta, Rajeswari, 2013. "Management of Capital Flows in India: 1990-2011," MPRA Paper 46217, University Library of Munich, Germany.
  6. 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, Department of Economics, Tufts University 0764, Department of Economics, Tufts University.

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