Non-linear analysis of international reserve, trade and trilemma in India

We examine the open-economy policy trilemma to gauge the stability of international macroeconomic arrangements. Using data from 1970 to 2017, we examine the relationship among the trilemma policy, foreign reserves and trade openness for the Indian economy. Using the ARDL Bound Test, we confirm the long-run relationship between the trilemma policy, foreign reserves and trade openness. Further, using a non-linear threshold model, we also estimate the foreign reserves threshold level for the Indian economy. Our findings suggest that a low foreign reserve level increases the policy dispersion in the trilemma. Therefore, it could be more difficult for the Government of India to achieve a stable exchange rate, independence of monetary policy and open economy concurrently. Further, we also report trilemma ineffectiveness when the foreign reserves are above the threshold. If this happens, it will harm the Indian economy in terms of reduction in real output and higher inflation.