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The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma

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  • Aizenman, Joshua

    (Asian Development Bank Institute)

  • Chinn, Menzie

    (Asian Development Bank Institute)

  • Ito, Hiro

    (Asian Development Bank Institute)

Abstract

This paper extends our previous paper (Aizenman, Chinn, and Ito 2008) and explores some of the unexplored questions. First, we examine the channels through which the trilemma policy configurations affect output volatility. Secondly, we investigate how trilemma policy configurations affect the output performance of the economies under severe crisis situations. Thirdly, we look into how trilemma configurations have evolved in the aftermath of economic crises in the past. We find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. While a higher degree of exchange rate stability could stabilize the real exchange rate movement, it could also make investment volatile, though the volatility-enhancing effect of exchange rate stability on investment can be cancelled by holding higher levels of international reserves (IR). Greater financial openness helps reduce real exchange rate volatility. These results indicate that policymakers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. We also find that the "crisis economies" could end up with smaller output losses if they entered the crisis situation with more stable exchange rates or if they continue to hold a high level of IR and maintain greater exchange rate stability during the crisis period. Lastly, we find that developing countries are often found to have decreased the level of monetary independence and financial openness, but increased the level of exchange rate stability in the aftermath of a crisis, especially for the last two decades. This finding indicates how vulnerable developing countries, especially emerging market ones, are to volatile capital flows as a result of global financial liberalization.

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File URL: http://www.adbi.org/working-paper/2010/04/19/3657.financial.crisis.gfa.trilemma/
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Bibliographic Info

Paper provided by Asian Development Bank Institute in its series ADBI Working Papers with number 213.

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Length: 43 pages
Date of creation: 19 Apr 2010
Date of revision:
Handle: RePEc:ris:adbiwp:0213

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Keywords: trilemma policy; capital outflows; investment channel; asia regional;

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Cited by:
  1. Aizenman, Joshua & Sengupta, Rajeswari, 2011. "The financial trilemma in China and a comparative analysis with India," MPRA Paper 34485, University Library of Munich, Germany.
  2. Bicaba, Zorobabel, 2011. "Growth and financial reforms trajectory: an optimal matching sequence analysis approach," MPRA Paper 34057, University Library of Munich, Germany.

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