Trilemma and Financial Stability Configurations in Asia

This paper takes stock of recent research dealing with the degree to which the trilemma choices of Asian countries facilitated a smoother adjustment during the global crisis of 2008– 2009, and the way the region has been coping with the adjustment to the postcrisis challenges. We point out that emerging Asia has converged to a middle ground of the trilemma configuration : limited financial integration, a degree of monetary independence, and controlled exchange rate buffered by sizable international reserves. This configuration, with the proper management of balance sheet exposure and public finances, facilitated a smoother adjustment of emerging Asia to the crisis, and was instrumental in inducing the rapid resumption of growth. The swings of financial flows, from large deleveraging of foreign positions in 2008 to the renewed inflows in 2010, validate the insight of the public finance approach to financial integration : the gains from deeper financial integration should be balanced against the costs of growing exposure to turbulences. A key lesson of the crisis is the need to apply a comprehensive cost/benefit approach to prudential policies, to the regulation of external borrowing and of domestic financial intermediation, and to the accumulation and use of international reserves. We illustrate these results in the context of the challenges facing emerging Asia’s adjustment during the global financial crisis, and the postcrisis policy stance dealing with the renewed inflows of capital.