The Mundell-Fleming Trilemma and the Global Financial Cycle: An Empirical Test of Competing Hypotheses

Josip Tica, Tomislav Globan and Vladimir Arčabić

Journal for Economic Forecasting, 2019, issue 3, 62-80

Abstract: We use an innovative methodological approach to investigate the impact of financial globalization (the dilemma hypothesis), the accumulation of international reserves (the quadrilemma hypothesis) and foreign currency exposure (the original sin hypothesis) on the Mundell-Fleming trilemma. We use a dynamic panel threshold model with four regimes to investigate competing hypotheses within a single methodological framework. The results imply that there are significant differences between fixed and flexible exchange rate regimes at high levels of financial openness, and that countries are biased towards fixed exchange rates at high levels of foreign currency exposure. These empirical findings imply that the global financial cycle might be the result of a deliberate choice of exchange rate regime and not the result of the irrelevance of the exchange rate regime in financially globalized countries.

Keywords: Mundell-Fleming; Global Financial Cycle; Foreign Currency Exposure; Trilemma; Dilemma (search for similar items in EconPapers)
JEL-codes: E42 F15 F31 F41 (search for similar items in EconPapers)
Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:rjr:romjef:v::y:2019:i:3:p:62-80

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