Submitted By mrkyo9x
Journal of International Money and Finance xxx (2014) 1e24
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Journal of International Money and Finance journal homepage: www.elsevier.com/locate/jimf
Living with the trilemma constraint: Relative trilemma policy divergence, crises, and output losses for developing countries
Joshua Aizenman a, 1, Hiro Ito b, * a b
University of Southern California and the NBER, University Park, Los Angeles, CA 90089-0043, USA
Department of Economics, Portland State University, 1721 SW Broadway, Portland, OR 97201, USA
a b s t r a c t
Exchange rate regime
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 relative policy divergence among the three trilemma policy choices, namely monetary independence, exchange rate stability, and ﬁnancial openness, we ﬁnd that emerging market countries have adopted trilemma policy combinations with the least degree of relative policy divergence in the last 15 years. We ﬁnd that a developing or emerging market country with a higher degree of relative policy divergence is more likely to experience a currency or debt crisis.
However, a developing or emerging market country with a higher degree of relative policy divergence tends to experience smaller output losses when it experiences a currency or banking crisis. Latin
American crisis countries tended to reduce their ﬁnancial integration in the aftermath of a crisis, while this is not the case for the Asian crisis countries. The Asian crisis countries tended to reduce the degree of relative policy divergence in the aftermath of the crisis, probably aiming at...