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Testing the trilemma: exchange rate regimes, capital mobility, and monetary independence

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  • Michael Bleaney
  • Hock-Ann Lee
  • Timothy Lloyd

Abstract

Previous research on the incompatibility of a pegged exchange rate, capital mobility, and monetary independence (the open-economy trilemma), based on the degree to which domestic interest rates follow foreign rates, has produced mixed results. Despite its centrality to other areas of investigation, such as currency crises, the role of the credibility of the peg has hitherto been ignored. Fluctuations in perceived devaluation probabilities will move domestic interest rates, given foreign interest rates, even if countries have no genuine monetary independence. Using data for 126 countries from 1990, it is shown that countries on credible pegs without capital controls follow foreign interest rates closely, and that the hypothesis of complete lack of monetary independence cannot be rejected in this case. Our findings are robust to alternative measures of credibility (inflation differentials; types of peg), and to different ways of classifying exchange rate regimes and identifying capital controls. Copyright 2013 Oxford University Press 2012 All rights reserved, Oxford University Press.

Suggested Citation

  • Michael Bleaney & Hock-Ann Lee & Timothy Lloyd, 2013. "Testing the trilemma: exchange rate regimes, capital mobility, and monetary independence," Oxford Economic Papers, Oxford University Press, vol. 65(4), pages 876-897, October.
    • Handle: RePEc:oup:oxecpp:v:65:y:2013:i:4:p:876-897
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    File URL: http://hdl.handle.net/10.1093/oep/gps038
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    Cited by:

    1. Mandilaras, Alex S., 2015. "The international policy trilemma in the post-Bretton Woods era," Journal of Macroeconomics, Elsevier, vol. 44(C), pages 18-32.
    2. Michael F. Bleaney & Mo Tian & Lin Yin, 2017. "De Facto Exchange Rate Regime Classifications: An Evaluation," Open Economies Review, Springer, vol. 28(2), pages 369-382, April.
    3. Lin, Yo-Long, 2017. "Is the price path learnable under a fixed exchange rate regime?," International Review of Economics & Finance, Elsevier, vol. 48(C), pages 355-366.
    4. Ms. Alla Myrvoda & Julien Reynaud, 2018. "Monetary Policy Transmission in the Eastern Caribbean Currency Union," IMF Working Papers 2018/070, International Monetary Fund.
    5. Herrala, Risto, 2020. "Capital controls in an integrated world: A review of recent developments, policies and the academic debate," BOFIT Policy Briefs 9/2020, Bank of Finland Institute for Emerging Economies (BOFIT).

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