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A modern reincarnation of Mundell-Fleming's trilemma

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  • Aizenman, Joshua

Abstract

A modern incarnation of the trilemma is essential for understanding the evolving global financial architecture, and for coming up with ways to mitigate financial fragility. The scarcity of policy instruments relative to the policy goals implies complex country-specific tradeoffs between the policy goals. The financial crises of the 1990s induced Emerging markets to converge to trilemma's middle ground -- managed exchange-rate flexibility, controlled financial integration, and viable but limited monetary independence. Capital flight crises added financial stability to trilemma's policy goals. New policies were added to deal with financial fragility associated with financial integration, including precautionary management of international reserves by emerging markets, swap lines among OECD's central banks, and macroeconomic prudential regulations. These trade-offs are impacted by a country's balance sheet exposure to hard currencies, the exchange-rate regime, and the growing sensitivity to shocks emanating from the U.S. and the Eurozone in the aftermath of the Global Financial Crisis.

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  • Aizenman, Joshua, 2019. "A modern reincarnation of Mundell-Fleming's trilemma," Economic Modelling, Elsevier, vol. 81(C), pages 444-454.
  • Handle: RePEc:eee:ecmode:v:81:y:2019:i:c:p:444-454
    DOI: 10.1016/j.econmod.2018.03.008
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    Keywords

    The impossible trinity; International reserves; Financial crises; Financial stability; Swap lines; Debt and banking crises; Balance sheet exposure;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls

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