Title: Does the policy trilemma still hold? Fresh evidence and its implications

Authors: Amit Ghosh

Addresses: Department of Economics, Illinois Wesleyan University, 1312 Park Street, P.O. Box 2900, Bloomington, IL 61702-2900, USA

Abstract: Economic success of any nation intrinsically hinges on the tradeoff between external policy choices and their internal consequences. An enduring challenge that countries confront is the 'trilemma' of choices between three desirable, yet jointly unattainable objectives of maintaining a fixed exchange rate regime, unfettered cross-border capital flows and monetary policy independence. This study examines the extent of monetary autonomy for over 130 nations spanning the period 1999-2011. Using both pooled cross-sectional as well as time series analyses I find more loss of monetary sovereignty for fixed regimes than non-fixed ones, supporting the trilemma's predictions. However, I do note this difference is only marginal and several floaters exhibit 'fear of floating' behaviour allowing sufficient transmission of foreign interest rates. Finally, I examine the macroeconomic consequences of the three tenets of the trilemma. I find higher monetary independence, greater capital openness as well as greater regime flexibility to promote economic stability.

Keywords: capital controls; exchange rate regimes; fear of floating; interest rate pass-through; monetary policy independence; policy trilemma; fixed exchange rates; cross-border capital flows; monetary autonomy; macroeconomics; monetary independence; capital openness; flexibility; economic stability.

DOI: 10.1504/IJMEF.2014.065079

International Journal of Monetary Economics and Finance, 2014 Vol.7 No.2, pp.81 - 106

Received: 27 Feb 2014
Accepted: 22 Apr 2014
Published online: 03 Mar 2015 *

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