The Trilemma: Insights and Limitations Menzie D. Chinn University of Wisconsin, Madison and NBER Universität Leipzig/Universität Duisburg Essen Conference on Exchange Rates, Monetary Policy and Financial Stability October 13, 2014 Leipzig
Remember Currency Wars? Remember the Taper Tantrum?.1.0 -.1 -.2 -.3 Thailand India Brazil S.Africa Turkey -.4 Log exchange rates against USD, 2013M05=0 Argentina -.5 M1 M2 M3 M4 M5 M6 M7 M8 M9 M10 M11 M12 M1 M2 2013 (1/24) 2
Outline 1. Progress in Measuring the Trilemma 2. The Evolution of the Trilemma, and Reserves 3. Reserve Accumulation, Again 4. Trilemma or Dilemma? 3
The Trilemma, aka The Impossible Trinity 4
Measuring the Trilemma Goals Monetary Independence corr( i i, i j ) 1 MI = 1 2 where i refers to home countries and j to the base country. Exchange Rate Stability 0.01 ERS 0.01 stdev( (log( exch _ rate)) 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. 5
Alternative Measures: Capital Openness Schindler Chinn-Ito Source: Quinn, Schindler, and Toyoda (2011) 6
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
Emerging Asian Economies Emerging Asian Economies Monetary Independence Financial Integration Exchange Rate Stability (Up to 2007).2.4 1971-80.6 1981-90 1991-2000.8 2001-08 1 International Reserves/GDP Note: This sample includes Taiwan, HK, Indonesia, Korea, Malaysia, Philipines, Singapore, Thailand, China 16
Emerging Asian Economies: 1971-80 Emerging Asian Economies Monetary Independence Financial Integration Exchange Rate Stability (Up to 2007).2.4 1971-80.6 1981-90 1991-2000.8 2001-08 1 International Reserves/GDP Note: This sample includes Taiwan, HK, Indonesia, Korea, Malaysia, Philipines, Singapore, Thailand, China 17
Emerging Asian Economies: 1971-90 Emerging Asian Economies Monetary Independence Financial Integration Exchange Rate Stability (Up to 2007).2.4 1971-80.6 1981-90 1991-2000.8 2001-08 1 International Reserves/GDP Note: This sample includes Taiwan, HK, Indonesia, Korea, Malaysia, Philipines, Singapore, Thailand, China 18
Emerging Asian Economies: 1971-2000 Emerging Asian Economies Monetary Independence Financial Integration Exchange Rate Stability (Up to 2007).2.4 1971-80.6 1981-90 1991-2000.8 2001-08 1 International Reserves/GDP Note: This sample includes Taiwan, HK, Indonesia, Korea, Malaysia, Philipines, Singapore, Thailand, China 19
Emerging Asian Economies: 1971-2008 Emerging Asian Economies Monetary Independence Financial Integration Exchange Rate Stability (Up to 2007).2.4 1971-80.6 1981-90 1991-2000.8 2001-08 1 International Reserves/GDP Note: This sample includes Taiwan, HK, Indonesia, Korea, Malaysia, Philipines, Singapore, Thailand, China 20
Emerging Asia ex.-china, and China Emerging Asian Economies and China Monetary Independence Financial Integration Exchange Rate Stability EMG Asia: 1990-96 EMG Asia: 1997-2000 EMG Asia: 2001-06.2.4.6.8 China: 1990-96 China: 1997-2000 China: 2001-06 1 International Reserves/GDP Note: The Emerging Asian Economies sample includes Indonesia, Korea, Malaysia, Philipines, and Thailand 21
Emerging Latin America Emerging Latin America Monetary Independence Financial Integration (Up to 2007) Center is at 0.2.4.6.8 1 International Reserves/GDP Exchange Rate Stability 1971-80 1981-90 1991-2000 2001-08 includes Argentina, Brazil, Chile, Colombia, Ecuador, Jamaica, Mexico, Peru, Trinidad and Tobago, and Venezuela. 22
Emerging LatAm: 1971-80 Emerging Latin America Monetary Independence Financial Integration (Up to 2007) Center is at 0.2.4.6.8 1 International Reserves/GDP Exchange Rate Stability 1971-80 1981-90 1991-2000 2001-08 23
Emerging LatAm: 1971-90 Emerging Latin America Monetary Independence Financial Integration (Up to 2007) Center is at 0.2.4.6.8 1 International Reserves/GDP Exchange Rate Stability 1971-80 1981-90 1991-2000 2001-08 24
Emerging LatAm: 1971-2000 Emerging Latin America Monetary Independence Financial Integration (Up to 2007) Center is at 0.2.4.6.8 1 International Reserves/GDP Exchange Rate Stability 1971-80 1981-90 1991-2000 2001-08 25
Emerging LatAm: 1971-2008 Emerging Latin America Monetary Independence Financial Integration (Up to 2007) Center is at 0.2.4.6.8 1 International Reserves/GDP Exchange Rate Stability 1971-80 1981-90 1991-2000 2001-08 Emerging Latin America include Argentina, Brazil, Chile, Colombia, Ecuador, Jamaica, Mexico, Peru, Trinidad and Tobago, and Venezuela. 26
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 27
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 28
Reserves, Again 29
Differing Paths Source: Bussiere, Chen, Chinn and Lisack (2014) 30
Insurance against GDP Loss Source: Bussiere, Chen, Chinn and Lisack (2014) 31
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? Rey, 2013 33
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 Klein and Shambaugh 2013 35
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 R F : a return in local country Z G : global factors - Policy rates, oil, commodity, gold - VIX, Ted X c : corresponding return Y : local factor (y/y IP growth) 37
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 countries 38
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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