Trilemma configurations in Asia in an era of financial globalization

This chapter examines how trilemma choices affect macroeconomic performance with focus on the Asian economies, and finds that these choices matter for output volatility and medium-term inflation, but do not matter for economic growth. Greater monetary independence is associated with lower output volatility while greater exchange rate stability implies greater output volatility, which can be mitigated if a country holds international reserves (IR) above a threshold of about 20% of the GDP. Greater monetary autonomy is associated with higher inflation, while greater exchange rate stability could result in lower inflation. Greater exchange rate stability could stabilize real exchange rate movements, yet it could also make investment more volatile, though this volatility-enhancing effect can be offset by higher levels of IR. Greater financial openness helps reduce real exchange rate volatility. Asian emerging market economies chose policy configurations and sizable IR to dampen the volatilities in both investment and real exchange rate.