The Trilemma: Insights and Limitationsmchinn/trilemma_insights_limitations...5 Measuring the Trilemma Goals Monetary Independence MI = 2 ( , ) 1 1 i j corr i i where i refers to home

The Trilemma: Insights and Limitations

Menzie D. ChinnUniversity of Wisconsin, Madison

and NBER

Universität Leipzig/Universität Duisburg Essen Conference on

“Exchange Rates, Monetary Policy and Financial Stability”

October 13, 2014Leipzig

-.5

-.4

-.3

-.2

-.1

.0

.1

M1 M2 M3 M4 M5 M6 M7 M8 M9 M10 M11 M12 M1 M2

2013

India

S.Africa

Turkey

Thailand

Brazil

Argentina

Log exchangerates against USD,2013M05=0

(1/24)

2

Remember Currency Wars? Remember the Taper Tantrum?

3

Outline

1. Progress in Measuring the Trilemma

2. The Evolution of the Trilemma, and Reserves

3. Reserve Accumulation, Again4. Trilemma or Dilemma?

4

The Trilemma, aka “The Impossible Trinity”

5

Measuring the Trilemma GoalsMonetary Independence

MI = 21),(

1

ji iicorr

where i refers to home countries and j to the base country.

Exchange Rate Stability

))_(log((01.001.0

rateexchstdev ERS

Financial Openness KAOPEN = Chinn-Ito (2006) index of capital account openness, based on

the information in IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions

All three indexes are normalized b/w 0 and 1. For all indexes, higher values indicate higher extents of achievement in each of the three policy goals.

Alternative Measures: Capital Openness

6Source: Quinn, Schindler, and Toyoda (2011)

Schindler

Chinn-Ito

Persistence (or Gates vs. Walls)

7

Indices for Industrial Countries

8

Indices for Emerging Markets

9

Indices for Less Developed Countries

10

Indices for Emerging Asia

11

Indices for Developing Asia

12

Indices for Latin America

13

Indices for Less Developed Countries ex.-Asia

14

How Do Reserves Fit In?

Trilemma measures are not perfect representations

Reserves can be accumulated in order to (temporarily) escape the trilemma

15

16

Emerging Asian Economies

Monetary Independence


International Reserves/GDP

Financial Integration.2

.4

.6

.8

1

1971-801981-90

Note: This sample includes Taiwan, HK, Indonesia, Korea, Malaysia, Philipines, Singapore, Thai land, China


1991-20002001-08

(Up to 2007)

17

Emerging Asian Economies: 1971-80





.4

.6

.8

1

1971-801981-90



1991-20002001-08

(Up to 2007)

18






.4

.6

.8

1

1971-801981-90



1991-20002001-08

(Up to 2007)

19






.4

.6

.8

1

1971-801981-90



1991-20002001-08

(Up to 2007)

20






.4

.6

.8

1

1971-801981-90



1991-20002001-08

(Up to 2007)

21

Emerging Asia ex.-China, and China




Financial Integration

.2

.4

.6

.8

1

EMG Asia: 1990-96

EMG Asia: 1997-2000EMG Asia: 2001-06

China: 1990-96China: 1997-2000China: 2001-06

Note: The Emerging Asian Economies sample includes Indonesia, Korea, Malaysia, Philipines, and Thailand

Emerging Asian Economies and China

22

Emerging Latin America

includes Argentina, Brazil, Chile, Colombia, Ecuador, Jamaica, Mexico, Peru, Trinidad and Tobago, and Venezuela.





.4

.6

.8

1

1971-801981-90

Center is at 0


1991-20002001-08

(Up to 2007)

23

Emerging LatAm: 1971-80





.4

.6

.8

1

1971-801981-90

Center is at 0


1991-20002001-08

(Up to 2007)

24






.4

.6

.8

1

1971-801981-90

Center is at 0


1991-20002001-08

(Up to 2007)

25






.4

.6

.8

1

1971-801981-90

Center is at 0


1991-20002001-08

(Up to 2007)

26


“Emerging Latin America” include Argentina, Brazil, Chile, Colombia, Ecuador, Jamaica, Mexico, Peru, Trinidad and Tobago, and Venezuela.





.4

.6

.8

1

1971-801981-90

Center is at 0


1991-20002001-08

(Up to 2007)

27

Evolution over Time Gradual, but steady increase in financial

integration among LDCs over the last 20 years Since the 1990s, emerging market countries

converged to the “middle-ground,” which means they pursued, along with financial liberalization, Managed exchange rate flexibility Medium level of monetary independence Sizable increase in IR holding

Emerging Asian economies differ from other groups with their balanced targeting and high levels of IR holdings

28

Punctuated Equilibria

Find structural breaks in the series of the indexes corresponding to major economic events

the collapse of the BW system

debt crisis of 1982

Asian crisis of 1997-98

the emergence of rapid globalization (1990) and the rise of China (2001)

Countries do alter policy configurations when they experience major shocks

Reserves, Again

29

Differing Paths

30Source: Bussiere, Chen, Chinn and Lisack (2014)

Insurance against GDP Loss

31Source: Bussiere, Chen, Chinn and Lisack (2014)

Insurance against GDP Loss

A doubling of the reserves-to-ST debt ratio is associated with a 0.4 to 0.5 percentage point faster growth rate during the global recession

32

A Global Financial Cycle?

33Rey, 2013

aka Trilemma or Dilemma?

Rey (2013) argues that in a financially integrated world, floating exchange rates do not insulate

Capital flow surges induce credit booms in the global financial cycle

Indisputable there are cycles But are exchange rate regimes

irrelevant, as Rey says?34

But Pegs Do Matter: Response to Base Country Interest Rate

35Klein and Shambaugh 2013

Still, the Trilemma Misses a Lot

The Trilemma is consistent with Mundell-Fleming

Intertemporal concerns not accounted for

Nor are credibility issues Like Mundell-Fleming, the banking

system is missing ==> New project: Aizenman,

Chinn, Ito (2014)36

2-step Process (a la Forbes-Chinn 2003): Step 1 estimate γ’s

37

RF : a return in local country ZG : global factors - Policy rates, oil, commodity, gold- VIX, Ted Xc : corresponding return Y : local factor (y/y IP growth)

Step 2 – Relate γ’s to Policies, Conditions, Institutions

OMP: Open Macro Policies - ERS, KAOPEN, reserve accumulation

MC: Macro conditions – infl. vol., CA, public finances (budget deficit or debt)

LINK: Imports, bank lending, FDI, trade competition

INST: ICRG based indicator CRISIS: currency and banking 1987(1993)-2012, 5 yr panels, 100

countries38

39

40

41

42

43

44

45

46

Other Links

Effective exchange rates Sovereign bond yields Financial stress Policy rates accounting for ZLB Exchange market pressure as a

function of global factors (incl. VIX, Ted)

47

Some Preliminary Observations

The Trilemma is a very useful framework

But it does seem to miss a lot of factors

There is more “friction” than we teach our students, but

It’s too soon to dispense with it

48

Documents

The Trilemma: Insights and Limitationsmchinn/trilemma_insights_limitations...5 Measuring the Trilemma Goals Monetary Independence MI = 2 ( , ) 1 1 i j corr i i where i refers to home