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

Joshua Aizenman and Hiro Ito

Asian Development Review, 2014, vol. 31, issue 2, 21-54

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. © 2013 Asian Development Bank and Asian Development Bank Institute.

Keywords: divergence; macroeconomic politics; trilemma hypothesis; crisis; Latin America 1980s; Asia 1990s (search for similar items in EconPapers)
JEL-codes: E00 E60 E65 E66 G01 N15 N16 P00 P52 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (5)

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