Monetary trilemma, dilemma, or something in between?

Abstract

This paper revisits the monetary “trilemma” versus “dilemma” debate by examining empirically interest-rate policy independence for a large sample of both advanced and developing countries over the period 1973–2014. We broadly concur with the growing body of literature that suggests that the trilemma still holds, emphasizing the important insulating effects afforded by exchange-rate flexibility. However, as with Han and Wei (2018), we also document the existence of an asymmetric pattern or 2.5-lemma between the trilemma and dilemma; though, in contrast to them, we find there seems to be evidence of a “fear of capital reversal” rather than a “fear of appreciation.” We further find that holding higher levels of foreign reserves may help countries regain a degree of monetary-policy autonomy.