Rounding the Corners of the Trilemma: A Simple Framework

Olivier Jeanne

No 16717, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Many emerging market economies use foreign exchange interventions capital controls or at the same time as they float their currencies, a policy mix that is not explained by Mundell's policy trilemma. This paper presents a simple model that accounts for this fact. In the model, changes in foreign appetite for domestic assets lead to a trade-off between stabilizing the tradable sector and stabilizing the nontradable sector. The model is consistent with a number of stylized facts about the impact of the global financial cycle on emerging market economies, and on the policies used by emerging markets to mitigate this impact. Consistent with Rey's dilemma thesis, the benefits of using countercyclical capital flow taxes may be substantially larger than the benefits of floating. The paper also discusses the reasons that capital flow taxes are not more popular in practice.

Date: 2021-11
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Journal Article: Rounding the corners of the trilemma: A simple framework (2022)
Working Paper: Rounding the corners of the trilemma: A simple framework (2021)
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