Working Paper: NBER ID: w30406
Authors: Joshua Aizenman; Menzie D. Chinn; Hiro Ito
Abstract: The “monetary trilemma” – the hypothesis that full monetary policy autonomy, exchange rate stability, and financial openness cannot simultaneously be achieved – has long been studied. Recently, holding international reserves (IR) has become an important policy instrument, insuring against liquidity shortages. We find that countries’ policy mixes are diverse, and have varied over time, sometimes in response to crises. We illustrate how the policy combinations changed drastically after the Asian Financial Crisis (AFC). In contrast, the Global Financial Crisis did not lead to a drastic change in the policy arrangements. We find that countries that faced large terms of trade shocks or negative economic growth during the crisis increased IR holding, post-AFC. Countries that had negative growth during the crisis also tended to pursue greater exchange rate flexibility and financial openness. This finding is true for commodity, but not manufactured goods, exporters. Countries with large current account deficits tend to be more sensitive to economic growth at the time of the AFC. Countries that are under IMF stabilization programs or those with sovereign wealth funds tended to hold more IR. In general, countries increased their IR holdings after the GFC, but did not otherwise respond concurrently to crisis conditions.
Keywords: Monetary Trilemma; International Reserves; Financial Crises
JEL Codes: F33; F38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Economic shocks (F69) | Increased international reserves holdings (F31) |
| Negative economic growth (F69) | Greater exchange rate flexibility (F31) |
| Negative economic growth (F69) | Greater financial openness (F30) |
| Current account deficits (F32) | Sensitivity to economic growth during crises (F44) |
| Economic growth (O00) | Policy responses (increased international reserves) (F31) |