The More Divergent, the Better? Lessons on Trilemma Policies and Crises for Asia

Asian Development Review 31:2

34 Pages Posted: 7 Apr 2016

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 12, 2014

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 extent of policy divergence among the three trilemma policy choices — monetary independence, exchange rate stability, and financial openness — we find that emerging market economies have adopted trilemma policy combinations with the smallest degree of policy divergence in the last 15 years.We then investigate whether and to what extent the degree of open macro policy convergence affects the probability of a crisis and find that a developing or emerging market economy with a higher degree of policy divergence is more likely to experience a currency or debt crisis.We also compare the development of trilemma policies around the crisis period for the groups of Latin American crisis countries in the 1980s and the Asian crisis countries in the 1990s.We find that Latin American crisis countries tended to close their capital accounts in the aftermath of a crisis, while that is not the case for the Asian crisis countries. The Asian crisis countries tended to reduce the degree of policy divergence in the aftermath of the crisis, which possibly meant they decided to adopt open macro policies that made their economies less prone to a crisis.

Keywords: impossible trinity, international reserves, financial liberalization, financial crisis, exchange rate regime

JEL Classification: F31, F36, F41, O24

Suggested Citation

Aizenman, Joshua and Ito, Hiro, The More Divergent, the Better? Lessons on Trilemma Policies and Crises for Asia (September 12, 2014). Asian Development Review 31:2. Available at SSRN: https://ssrn.com/abstract=2758975

Joshua Aizenman

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 (Contact Author)

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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