tel-05145036 New Challenges for Macroeconomic Policies : Revisiting the Mundell-Fleming Trilemma

Developed by Mundell-Fleming, the famous Trilemma (impossibility triangle) introduces a policy tradeoff between three policy goals: financial integration, monetary autonomy, and exchange rate stability (Mundell, 1963). It suggests that only two out of the three policy goals can be achieved. If capital is perfectly mobile, monetary policy under flexible exchange rates will be more effective than under fixed exchange rates. Nonetheless, gains from this theory are being challenged in the current international monetary and financial system (IMFS).This thesis aims to analyze the impact of new macroeconomic policy challenges within a revisited trilemma perspective. First, in Part 1, we re-examine the three dimensions of the Trilemma: financial integration, monetary autonomy, and exchange rate stability, and discuss their evolution in the modern era. Chapter 1 proposes new measures of financial integration using a non-linear approach of factor models (Principal Component Analysis (PCA) and a logistic PCA). Our indexes depict the trend of financial flows and the capital account restrictions. They reveal a managed financial integration going along with the popularity of capital control tools. Despite an upward trend, the de facto measure of financial integration drops during crisis periods, and de jure integration falls as policymakers use capital controls to limit capital depletion and its negative effect. In Chapter 2, we estimate the network of monetary policy and examine how the global international system may affect domestic monetary autonomy. We confirm the existence of a global network within which monetary policy (in advanced and emerging economies) spills over and back from one economy to another. Shocks from advanced economies dominate the network, and emerging countries remain net receivers of shocks. We document spillover and spillback effects between large emerging and advanced economies' policy rates. Using a time-varying framework, we propose a novel measure of monetary autonomy, which captures the aggregate response of domestic monetary policy to monetary policy shocks from the network. Positively correlated with the degree of globalization, the index confirms that emerging market economies are more vulnerable to shocks from the network, and their response is more volatile. Chapter 3 confirms empirically that the emergence and proliferation of intermediate regimes have broken the polar view of the exchange rate system. It explores the mismatch between de jure and de facto exchange rate regimes and identifies poor institutional quality and large financial deepness in emerging economies as the key drivers of this mismatch. Hence, we argue that the Trilemma has morphed into a middle-ground equilibrium with a multi-dimension tradeoff between financial integration and capital account management, exchange rate regime, and financial stability (foreign exchange policy).The second part of the thesis (Part 2) focuses on the impact of the US dominance on the Trilemma. We propose a broad proxy of dollar dominance and assess its effect on countries' vulnerability to the US dollar. Using local projection models, Chapter 5 suggests that central bankers in heavy dollar-dependent economies are more likely to follow the US monetary policy to tame the adverse effects of the local currency's depreciation. However, high foreign reserves hoarding and large foreign exchange intervention help reduce the vulnerability to US monetary policy. Chapter 6 argues, within a theoretical framework à la Gopinath et al. (2019), that this intermediate regime with partial monetary autonomy and managed exchange rate regime is optimal to ensure the best stabilization of national variables in case of adverse foreign shocks.