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date: 22 January 2020

Abstract and Keywords

We examine the development of open macroeconomic policy choices among developing economies from the perspective of the powerful “trilemma” hypothesis. Using the “trilemma indexes” (Aizenman, Chinn, and Ito, 2010) that measure the extent of achievement in monetary independence, exchange rate stability, and financial openness, we observe that the three dimensions of the trilemma configurations are converging toward a “middle ground” among emerging market economies with managed exchange rate flexibility, underpinned by sizable holdings of international reserves and intermediate levels of monetary independence and financial integration. We also find emerging market economies with more converged policy choices have tended to experience smaller output volatility in the last two decades. Emerging markets with low levels of international reserves holding could experience higher levels of output volatility when they choose a policy combination with a greater degree of policy divergence, while it does not apply to economies with high levels of international reserves holding. These results indicate that holding a high volume of international reserves may give room to emerging market economies to choose a policy combination from a wider spectrum of policy combinations.

Keywords: Impossible trinity, international reserves, financial liberalization, exchange rate regime

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