Living with the Trilemma Constraint: Relative Trilemma Policy Divergence, Crises, and Output Losses for Developing Countries

43 Pages Posted: 20 Sep 2013

See all articles by Joshua Aizenman

Joshua Aizenman

University of Southern California - Department of Economics; National Bureau of Economic Research (NBER)

Hiro Ito

Portland State University - Department of Economics

Date Written: September 2013

Abstract

This paper investigates the potential impacts of the degree of divergence in open macroeconomic policies in the context of the trilemma hypothesis. Using an index that measures the relative policy divergence among the three trilemma policy choices, namely monetary independence, exchange rate stability, and financial openness, we find that emerging market countries have adopted trilemma policy combinations with the least degree of relative policy divergence in the last fifteen years. We also find that a developing or emerging market country with a higher degree of relative policy divergence is more likely to experience a currency or debt crisis. However, a developing or emerging market country with a higher degree of relative policy divergence tends to experience smaller output losses when it experiences a currency or banking crisis. Latin American crisis countries tended to reduce their financial integration in the aftermath of a crisis, while this is not the case for the Asian crisis countries. The Asian crisis countries tended to reduce the degree of relative policy divergence in the aftermath of the crisis, probably aiming at macroeconomic policies that are less prone to crises. The degree of relative policy divergence is affected by past crisis experiences - countries that experienced currency crisis or a currency-banking twin crisis tend to adopt a policy combination with a smaller degree of policy divergence.

Suggested Citation

Aizenman, Joshua and Ito, Hiro, Living with the Trilemma Constraint: Relative Trilemma Policy Divergence, Crises, and Output Losses for Developing Countries (September 2013). NBER Working Paper No. w19448. Available at SSRN: https://ssrn.com/abstract=2328495

Joshua Aizenman (Contact Author)

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall, 300
Los Angeles, CA 90089
United States

National Bureau of Economic Research (NBER) ( email )

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

Register to save articles to
your library

Register

Paper statistics

Downloads
8
Abstract Views
153
PlumX Metrics