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The financial trilemma in China and a comparative analysis with India

  • Aizenman, Joshua
  • Sengupta, Rajeswari

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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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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  1. Hutchison, Michael & Kendall, Jake & Pasricha, Gurnain & Singh, Nirvikar, 2010. "Indian Capital Control Liberalization: Evidence from NDF Markets," MPRA Paper 21771, University Library of Munich, Germany.
  2. Joshua Aizenman & Menzie D. Chinna & Hiro Ito, 2010. "The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma," Trade Working Papers 21873, East Asian Bureau of Economic Research.
  3. Joshua Aizenman & Reuven Glick, 2008. "Sterilization, monetary policy, and global financial integration," Working Paper Series 2008-15, Federal Reserve Bank of San Francisco.
  4. 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.
  5. Hutchison, Michael & Sengupta, Rajeswari & Singh, Nirvikar, 2010. "India’s trilemma: financial liberalization, exchange rates and monetary policy," MPRA Paper 25327, University Library of Munich, Germany.
  6. Glick, Reuven & Hutchison, Michael, 2009. "Navigating the trilemma: Capital flows and monetary policy in China," Journal of Asian Economics, Elsevier, vol. 20(3), pages 205-224, May.
  7. S. Mahendra Dev, 2008. "India," Chapters, in: Handbook on the South Asian Economies, chapter 1 Edward Elgar.
  8. Patnaik, Ila & Shah, Ajay & Sethy, Anmol & Balasubramaniam, Vimal, 2011. "The exchange rate regime in Asia: From crisis to crisis," International Review of Economics & Finance, Elsevier, vol. 20(1), pages 32-43, January.
  9. Ajay Shah, 2008. "New issues in Indian macro policy," Working Papers id:1478, eSocialSciences.
  10. 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.
  11. Sebastian Edwards & Eduardo Levy Yeyati, 2004. "Flexible Exchange Rates as Shock Absorbers," Business School Working Papers exchangerates, Universidad Torcuato Di Tella.
  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.
  15. 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.
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