Sweden's Trilemma Trade-offs

In this paper, we empirically examine the theoretical concept of “impossible trinity” (financial trilemma) for Sweden for the period of 2010-2017. While doing this, we modified the Aizenman, Chinn and Ito approach by adding an extra interaction term to the main regression which shows whether these three policies are implemented in harmony without creating any trade-offs. Similarly, this interaction term also reflects the effectiveness of all supportive policies (i.e. hoarding international reserves, liquidity policies etc.) in order to eliminate the trade-offs between the monetary independence, exchange rate stability and capital openness. Our results indicate that the standard ACI approach is not sufficient in explaining Sweden’s economic policies and adding an interaction term to the main trilemma regression is both necessary and critical. From the latter perspective, the interaction term has a negative contribution indicating that Sweden could achieve to relax the binding trilemma trade-offs in this period. Lastly, our analysis continues by exploring the implications of the interaction term for inflation in a VAR and Granger Causality analyses where we find that interaction term has certain decreasing impact on inflation.