Surfing the Waves of Globalization: Asia and Financial Globalization in the Context of the Trilemma

56 Pages Posted: 29 May 2010

See all articles by Joshua Aizenman

Joshua Aizenman

National Bureau of Economic Research (NBER)

Menzie David Chinn

University of Wisconsin, Madison - Robert M. La Follette School of Public Affairs and Department of Economics; National Bureau of Economic Research (NBER)

Hiro Ito

Portland State University - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: November 2009

Abstract

Using the “trilemma indexes” developed by Aizenman et al. (2008) that measure the extent of achievement in each of the three policy goals in the trilemma — monetary independence, exchange rate stability, and financial openness — this paper examines how policy configurations affect macroeconomic performances with focus on the Asian economies. We find that the three policy choices do not matter for per capita economic growth. However, they do matter for output volatility and the medium-term level of inflation. Greater monetary independence is associated with lower output volatility while greater exchange rate stability implies greater output volatility, which can be mitigated if a country holds international reserves (IR) at a higher level than a threshold (about 20% of gross domestic product). Greater monetary autonomy is associated with a higher level of inflation while greater exchange rate stability and greater financial openness could lower the inflation level. 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 IR. Greater financial openness helps reduce real exchange rate volatility. These results indicate that policy makers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. Asian emerging market economies are found to be equipped with macroeconomic policy configurations that help the economies to dampen the volatilities in both investment and real exchange rate. These economies’ sizeable amount of international reserves holding appears to help enhance the stabilizing effect of the trilemma policy choices, which explains the recent phenomenal buildup of international reserves in the region.

Keywords: Impossible trinity, international reserves, financial liberalization, exchange rate, FDI flows

JEL Classification: F15, F21, F31, F36, F41, O24

Suggested Citation

Aizenman, Joshua and Chinn, Menzie David and Ito, Hiro, Surfing the Waves of Globalization: Asia and Financial Globalization in the Context of the Trilemma (November 2009). Asian Development Bank Economics Working Paper Series No. 180. Available at SSRN: https://ssrn.com/abstract=1617149 or http://dx.doi.org/10.2139/ssrn.1617149

Joshua Aizenman (Contact Author)

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
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Menzie David Chinn

University of Wisconsin, Madison - Robert M. La Follette School of Public Affairs and Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706-1393
United States
608-262-7397 (Phone)
608-262-2033 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Hiro Ito

Portland State University - Department of Economics ( email )

Portland, OR 97207-0751
United States
503-725-3930 (Phone)
503-725-3945 (Fax)

HOME PAGE: www.econ.pdx.edu

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