Working Paper: NBER ID: w19461
Authors: Michael W. Klein; Jay C. Shambaugh
Abstract: A central result in international macroeconomics is that a government cannot simultaneously opt for open financial markets, fixed exchange rates, and monetary autonomy; rather, it is constrained to choosing no more than two of these three. In the wake of the Great Recession, however, there has been an effort to address macroeconomic challenges through intermediate measures, such as narrowly targeted capital controls or limited exchange rate flexibility. This paper addresses the question of whether these intermediate policies, which round the corners of the triangle representing the policy trilemma, afford a full measure of monetary policy autonomy. Our results confirm that extensive capital controls or floating exchange rates enable a country to have monetary autonomy, as suggested by the trilemma. Partial capital controls, however, do not generally enable a country to have greater monetary control than is the case with open capital accounts unless they are quite extensive. In contrast, a moderate amount of exchange rate flexibility does allow for some degree of monetary autonomy, especially in emerging and developing economies.
Keywords: monetary policy autonomy; policy trilemma; capital controls; exchange rates
JEL Codes: E52; F3; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| extensive capital controls (F38) | monetary autonomy (E42) |
| floating exchange rates (F31) | monetary autonomy (E42) |
| partial capital controls (F38) | monetary control (E50) |
| moderate exchange rate flexibility (F31) | monetary autonomy (E42) |
| temporary capital controls (F38) | monetary autonomy (E42) |
| moderate capital controls (F38) | monetary autonomy (E42) |
| flipping exchange rate regimes (F31) | nature of the policy trilemma (E61) |
| interest rate closely follows base country (E43) | pegged exchange rate (F31) |
| interest rate diverges from base country (E43) | not pegged exchange rate (F31) |
| greater exchange rate flexibility (F31) | monetary autonomy (E42) |