Trilemma Policy Convergence Patterns and Output Volatility
29 Pages Posted: 19 Apr 2012 Last revised: 25 Jul 2022
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Trilemma Policy Convergence Patterns and Output Volatility
Trilemma Policy Convergence Patterns and Output Volatility
Date Written: April 18, 2012
Abstract
This working paper was written by Joshua Aizenman (University of California, Santa Cruz
and National Bureau of Economic Research) and Hiro Ito (Portland State University).
We examine the development of open macroeconomic policy choices among developing economies from the perspective of the powerful “trilemma” hypothesis. We construct an index of divergence of the three trilemma policy choices, and evaluate its patterns in recent decades. We find that the three dimensions of the trilemma configurations are converging towards a “middle ground” among emerging market economies, equipped with managed exchange rate flexibility, underpinned by sizable holdings of international reserves, and intermediate levels of monetary independence and financial integration. We also find emerging market economies with more converged policy choices tend to experience smaller output volatility in the last two decades. Emerging markets with relatively low international reserves/GDP could experience higher levels of output volatility when they choose a policy combination with a greater degree of policy divergence while this heightened output volatility effect does not apply to economies with relatively high international reserves/GDP holding.
Keywords: Impossible Trinity, International Reserves, Financial Liberalization, Exchange Rate Regime
JEL Classification: F31, F36, F41, O24
Suggested Citation: Suggested Citation
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