Independent Monetary Research Articles

A First Look at the Trilemma Vis-à-Vis Quadrilemma Monetary Policy Stance in a Pacific Island Country Context

Initiated by a central bank, this is the first study to examine and understand the trilemma as well as the quadrilemma monetary policy challenges in the case of Pacific Island countries. Taking Fiji as an example, over the 1975–2013 period, the trilemma, monetary independence and exchange rate stability might have been the more fervently pursued stance; the quadrilemma focus appears to have shifted to foreign reserves and capital account openness. When the full sample period is split into two subsamples, results show that the policy emphasis might have shifted from monetary independence, capital account openness, and foreign reserves to exchange rate stability, monetary independence, and foreign reserves. Policy implications are discussed.

Threefold Policies for Bank Development: Do Independence and Transparency Matter?

A well-developed banking sector is crucial to achieve a sustained economic growth. To attain this goal, both central banks and government have embraced operational and institutional arrangements. In this paper, I offer an empirical lookup on how monetary independence and transparency of macroprudential and fiscal policies are linked to bank development. Drawing upon a panel dataset for the period 1998-2014, I find that both macroprudential transparency (proxied by central bank financial stability transparency) and fiscal transparency are positively related to the share of credit granted by banks to the private sector, implying that more transparency enhances bank development. More independence from central banks seems, however, to decrease the ratio of bank credit to GDP. By considering interactions, the marginal effect of central bank financial stability transparency on bank credit/GDP, conditional on the levels of independence, is positive but decreases under a particular range of independence values. If central bank independence interacts with fiscal transparency, the marginal effect of fiscal transparency is positive and significant over a specific range of the degree of central bank independence but there is no statistical support that the marginal effect decreases within the same range unless I use the independence index of Garriga (2016).

Financial Adjustment in Small, Open Economies in Light of the “Impossible Trinity” Trilemma

The study examines the resilience of small and open European economies to external shocks and the various types of financial integration adjustment in an empirical approach for the period between 1993 and 2016. External financial integration has been implemented in all of the examined countries, offering payment channels fully or largely open to foreign countries. The only major difference was in the level of monetary independence and foreign exchange rate stability. We were able to differentiate between two types of adjustment: in type A, financial policy was characterised by a greater level of monetary independence and a lower level of exchange rate stability, while countries that can be classified under type B practically gave up their monetary independence with their euro area membership, and opted for full exchange rate stability. But resilience to external shocks depends not only on the choices determined by the impossible trinity, but also on other macro-prudential factors, especially on the stability of budgetary processes and the repayment of external foreign currency debts. The difficulty to adjust, transcending beyond the limitations of the “trinity tradeoff”, was confirmed by the case of Portugal and Greece using the euro as their local currency, while the example of the non-euro area member Czech Republic illustrated a traditionally conservative, monetarily independent and successful external financial adjustment, built on flexible exchange rates and interest spreads. Hence there were many types of adjustment, where euro area membership in itself did not mean “bulletproof” protection in every respect. Hungary possibly joining the euro area would certainly improve its external financial resilience, but it would not make the existing competitiveness/development deficits disappear.

OPERATING THE IMPOSSIBLE TRINITY BEFORE AND AFTER THE GLOBAL FINANCIAL CRISIS 2007-2008: EVIDENCE IN VIETNAM

This paper focuses on analysing the changes in the impossible trinity administration in Vietnam before and after the global financial crisis 2007-2008. Using the indices representing the impossible trinity, including MI, ERS, and FO, as well as the regression models based on the ARDL method, the authors found that during the study period, the Vietnamese government had selected the exchange rate stability on the list of priorities. The combination with another goal in the impossible trinity, however, changed over two phases. In the period before the crisis, the financial integration was more focused while in the period after the financial crisis, the goal of monetary independence received greater attention. We also discovered that the Vietnamese government was likely to regulate the impossible trinity policies under the intermediary regime that showed the indicators of the impossible trinity with the value approaching 0.5.

A Modern Reincarnation of Mundell-Fleming's Trilemma

A modern incarnation of the trilemma is essential for understanding the evolving global financial architecture, and for coming up with ways to mitigate financial fragility. The scarcity of policy instruments relative to the policy goals implies complex country-specific tradeoffs between the policy goals. The financial crises of the 1990s induced Emerging markets to converge to trilemma’s middle ground -- managed exchange-rate flexibility, controlled financial integration, and viable but limited monetary independence. Capital flight crises added financial stability to trilemma’s policy goals. New policies were added to deal with financial fragility associated with financial integration, including precautionary management of international reserves by emerging markets, swap lines among OECD’s central banks, and macroeconomic prudential regulations. These trade-offs are impacted by a country’s balance sheet exposure to hard currencies, the exchange-rate regime, and the growing sensitivity to shocks emanating from the U.S. and the Eurozone in the aftermath of the Global Financial Crisis.

Actual monetary policy independence in a small open economy: the Polish perspective

The aim of this article is to examine the actual degree of monetary policy independence in a small open economy with floating exchange rate that is integrated with the world economy. It is frequently argued that for such a country the primary cost of participation in a currency area is the loss of monetary policy independence. The article raises the question if the proposition of monetary independence provided by floating exchange rate applies to a small open economy, operating within highly liberalised capital flows and highly integrated financial markets. We examine the actual degree of monetary policy independence in Poland using a vector error correction mechanism model and the data for the years 2001–2014. We obtain evidence pointing to the lack of such independence, and we show that this result is robust to extensive changes in specification, including impulse saturation.

THE MACROECONOMICS OF A DELAYED RECOVERY FROM THE GLOBAL FINANCIAL CRISIS: A COMPARATIVE APPROACH

This paper compares Denmark's growth performance to that of the other 18 non-Eurozone OECD economies during 2008–2013. Denmark is the only country with a fixed exchange-rate regime; all the other 18 countries have flexible exchange rates, mostly as part of an inflation-targeting (IT) framework. At the same time, Denmark is the worst growth performer of all. Our analysis indicates that the lack of monetary policy independence is central to understanding the meager Danish performance. Monetary easing during 2008–2009 is an important predictor of economic growth during 2008–2013, and Denmark, having outsourced monetary policy to the ECB, did not pursue monetary easing as aggressively as most other countries. In fact, the Danish Central Bank was forced to raise its policy interest rate in 2008Q4 in order to defend the euro-peg. Overall, the Danish experience serves as a reminder that fixed exchange rates can be quite taxing on economic growth in the aftermath of a huge negative shock.

The relationship between monetary policy and economic development in modern Europe: Problems and possible solutions

The author analyzes the risks of dismantling of the European Union posed by the current monetary policy, under which the single currency of the European Union not only retarded economic growth, but also led to economic contraction and high unemployment. Analyzing the widely debated idea of federalization as a way to tackle the challenge of Euroscepticism in major European countries and estimating the net transfers that are necessary for the proper functioning of the recipient country, the author concludes that federalization can only be considered a real action provided the current policy pursued by Germany as the hegemon of the European Union is to change. In the conclusion, the article reviews the problem of monetary independence as a necessary condition for the implementation of a national industrial policy based on the experience of France.

Threats to monetary policy independence: reasons to be concerned

Several legislative efforts are under way that aim to impose greater congressional oversight of and influence on the monetary policy decision making of the Federal Reserve System. Some of these initiatives might do little harm or even make marginal improvements. But others pose more serious threats to the operational independence of monetary policy. Proposals to require the Federal Reserve to frame monetary policy decisions according to a mathematical formula imply a concrete simplicity of policy that is inaccurate and misleading. And the reporting requirements associated with these proposals threaten to negate the major advantage of monetary policy as a countercyclical weapon—speed. Proposals to subject the non-monetary policy functions of the Fed to the appropriations process provide Congress with additional leverage that could be used to apply pressure to monetary policy decisions. For its part, the Fed should continue to increase transparency through more timely and complete release of relevant information and analysis. To best promote the objectives of stable prices and maximum employment, the operational independence of the Federal Reserve’s monetary policy decision making needs to be preserved and protected.

Monetary policy effect in an economy with heavily managed exchange rate

The primary objective of this paper is to investigate the effect of monetary policy on macroeconomic variables in Vietnam, which is a small, open, and developing economy with heavily managed ex-change rate. Monetary policy shock is identified by the sign re-striction methodology. Unlike previous studies, this paper identifies a monetary contraction by a combination of an increase in interest rates, a decrease in central bank credit, a drop in the stock of foreign exchange reserves, and a fall in broad money. The empirical results show that output and prices begin to reduce after a restrictive mone-tary shock in the medium term, suggesting the adverse effect of monetary policy in the short term and the necessity to improve the transparency of monetary setting. Meanwhile, exchange rates are unresponsive to a tightening decision, which is not a sign of puzzle but plausible when the nature of a peg regime is taken into account. Furthermore, foreign exchange policy causes inflation to rise since its effect is partially sterilized by changes in monetary policy instru-ments. Therefore, Vietnamese monetary authorities should consider a shift toward a more floating regime to achieve monetary inde-pendence or foster the development of financial markets in order to alleviate inflationary pressure caused by foreign exchange policy.

Evaluating South Africa's Open Economy

AbstractThe competing theories of the macroeconomic trilemma and dilemma are empirically tested for South Africa. The empirical findings show evidence of the trilemma theory being applicable to South Africa, supporting the country's ability to maintain monetary independence (MI). An empirical puzzle, however, emerged as South Africa's MI index decreased during the country's 2000–2014 inflation‐targeting period. A possible explanation, and subject for further research, is that the increasing opening of South Africa to international flows since 1995 may have caused South Africa to be more exposed to international business cycles and shocks, resulting in a reduction in measured MI.

The Effect of Fixed Exchange Rates on Monetary Policy of the GCC Countries

The GCC member countries have maintained fixed exchange rates against the US dollar for a long time now. These countries also allow liberal cross-border capital movements. Given these arrangements, they have theoretically given up the monetary independence according to the trilemma stating that countries with fixed exchange rates cannot pursue both domestic monetary independence and free capital mobility. This paper tests trilemma for the GCC member countries excluding Saudi Arabia and the UAE due to the unavailability of the pertinent interest rates data from these countries. Using the most recent quarterly data for the period 2004 to 2015, the general finding is that these countries still have some monetary independence. Results for Qatar indicate that they can maintain a full monetary autonomy if the circumstances make them to do so.

The political economy of the impossible trinity

This paper reconsiders the policy trilemma in an open economy by incorporating political economy concerns. We argue that the impact of government ideology on monetary independence, exchange rate stability, and capital flow restrictions should be analyzed in the broader context of restrictions imposed by the impossible trinity instead of the usual single-dimensional constraints. Employing a de facto measurement of these restrictions for a sample of 111 countries from 1980 to 2010, we show that the impact of government ideology on a country's position in this trilemma is highly context dependent: we find that its impact on exchange rate stability and monetary independence varies between developed and developing countries. We also show that the impact of government ideology on these two trilemma components is contingent on the stance of the respective economy's business cycle. Left-leaning governments seem to favor exchange rate stability over monetary independence in case of a negative output gap; suggesting a reversal of their commonly assumed partisan preferences in economically tight times.

Is India Ready for Inflation Targeting?

In this paper we analyze the extent to which the current macroeconomic environment in India is suitable for implementation of inflation targeting as a monetary policy strategy, in light of the recommendation of the Urjit Patel Committee Report. Our results indicate that historically the Reserve Bank of India has given more importance to inflation compared to output growth and exchange rate changes in its monetary policy conduct and that in recent times there has been an increased emphasis on monetary independence thereby comfortably placing the RBI on a path to move towards inflation targeting. However we also find factors, that are traditionally outside the control of monetary policy, do exert a strong impact on aggregate prices in India thereby making the choice of nominal anchor a tricky one. Furthermore, the success of monetary policy in containing inflation is found to be crucially contingent on an appropriate fiscal policy as well.

Exchange Rate Flexibility, Financial Market Openness and Economic Growth

With global recovery not in sight, along with calls for stronger structural reform, international policy coordination is again under spotlight. Correcting global imbalance would contribute towards closing the demand gap. Emerging economies in particular should allow greater exchange rate flexibility and not intervene in the foreign exchange market to reflect fundamentals. Yet, the impact of greater exchange rate flexibility is unclear as they also struggle to keep their growth momentum alive and hedge against greater exposure to potential capital reversal than ever before. With the loss of monetary policy independence, emerging markets (EMs) are running out of policy options. Against this background, unless international policy coordination is fundamentally recast, a comprehensive review of all emerging market economies’ policy options are in order, including both macro policy instruments, micro measures, and global safety net aimed at attaining the best possible solution to escaping global recession.

Global Financial Crisis, Capital Inflows and Policy Trilemma: An Analysis of the Indian Experience

In the context of the global financial crisis, this article analyzes the behaviour of capital inflows in India during the period from 1993.2 to 2012.4. It also examines the question, how have the policy makers in India dealt with the ‘policy trilemma’ in a regime of liberalized capital inflows? The study finds that the volatility of capital inflows increased after the global financial crisis. Further, due to the global financial crisis, there were substantial changes in the relative importance of the factors that explain capital inflows. Although the ‘pull factors’ played major roles in both the periods, before and after the crisis, there were significant changes in their relative importance. In the first sub-period, real effective exchange rate and foreign exchange reserves played the most important roles in determining the capital inflows whereas in the second sub-period, it was only current account balance. While dealing with ‘policy trilemma’, we observed that the monetary policy independence was maintained in the period before the crisis which was sacrificed in the later period. JEL Classification: F30, F32, F39

The Risk Premium, Interest Rate Determination, and Monetary Independence Under a Fixed, but Adjustable, Exchange Rate

AbstractThis paper examines interest rate determination and monetary independence in a small economy with a fixed exchange rate. The risk premium is determined endogenously in the stochastic, general‐equilibrium model. The sign of the risk premium and the magnitude of the interest rate depend on the specification of the policy rule for the future exchange rate. Increases in domestic credit can decrease, increase or have no effect on the interest rate. The offset coefficient can differ from −1 (the ‘trilemma’ may not hold), but numerical calculations indicate that the offset is close to −1. Under certain conditions, empirical analyses overestimate monetary independence. Copyright © 2016 John Wiley & Sons, Ltd.

The Credibility of the Somali Central Bank: Independence, Transparency, and Accountability

The very purpose of this study is to review the credibility of the Somali central bank: its independence, transparency, and accountability. The reason why, this study was conducted is that there was no previous study in its kind regarding the credibility of the central bank of Somalia by looking at its independence, transparency and accountability. The first objective of this study is to find out if central bank of Somalia is credible in terms of political, financial, and monetary policy independence. The second objective is to examine the types and degree of transparency and to settle ways to measure the transparency of the Somali central bank. The third objective is to find out if there are clear and well defined financial accountability structures in the central bank (CB) of Somalia. In this study, central bank independence (CBI), transparency, and accountability was measured to find out whether these elements can influence or possibly could have some positive effects on central bank credibility. The questionnaire used in this research is a self-administered dichotomous scale. Data was analyzed by using Statistical package for social sciences (SPSS) in descriptive statistics. The target population of this study was 32 respondents from the banking industry in Mogadishu. The result of this study became 55.78 mean averages with a Std. Dev. 5.235. The overall mean averages for a total of 30 questions became 1.859 and overall Std. Dev. 0.1745 which meant the result showed greater abnormality and data distribution positively skewed to the right. The central bank of Somalia has no independence.

Euro Dominance Hypothesis and Monetary Policy Independence the Czech Perspective

In this article, we investigate the actual level of monetary policy independence in the Czech Republic. We formulate the research agenda in terms of the Euro Dominance Hypothesis. The situation of the non-euro EU countries with derogation in terms of joining the EMU, like the Czech Republic, is similar to the pre-euro situation of the euro area countries, in which the problem of the stability of the European Mechanism System was predominant. We investigate the co-movement of interest rates between the Czech Republic and the Eurozone to assess the potential costs of monetary integration. Using cointegration and VECM methods we show that the ECB monetary policy influences monetary policy in the Czech Republic and the actual level of monetary independence in the Czech Republic is much lower than it is presumed. Therefore, we argue that for the Czech Republic the cost of the joining the EMU will be lower than expected.

Euro Dominance Hypothesis and Monetary Policy Independence – the Czech Perspective

In this article, we investigate the actual level of monetary policy independence in the Czech Republic. We formulate the research agenda in terms of the Euro Dominance Hypothesis. The situation of the non-euro EU countries with derogation in terms of joining the EMU, like the Czech Republic, is similar to the pre-euro situation of the euro area countries, in which the problem of the stability of the European Mechanism System was predominant. We investigate the co-movement of interest rates between the Czech Republic and the Eurozone to assess the potential costs of monetary integration. Using cointegration and VECM methods we show that the ECB monetary policy influences monetary policy in the Czech Republic and the actual level of monetary independence in the Czech Republic is much lower than it is presumed. Therefore, we argue that for the Czech Republic the cost of the joining the EMU will be lower than expected.