The famous trilema is economics is the ability of a country to be able to control the interest rates, to control exchange rate and to allow free movement of capital. A country can control only two of the three points mentioned above. For example, US controls interest rates, allows free movement of capital and does not have the ability to control exchange rate. China controls interest rates, controls exchange rate and does not allow free movement of capital. India on the other hand, controls interest rates but keeps switching one of the two 'on' at a given time, which predominantly has been to allow free movement of capital. As the topic states the question is do emerging economies really have the ability to choose their two out of three choices provided.
Graph 1 shows the movement of the US central bank rate and the Indian central bank rate and Graph 2 shows the US 10 yr Treasury yields and the Indian central bank rates.
As illustrated in Graph 1, the Indian central bank rate movements have been in sync with the movement of the US central bank rates for the period from 2000 to 2008. This has been an era of increased movement of capital from developed economies to the emerging economies and an era of very high liquidity in the global markets. Since 2008, US central bank has kept the rates constant whereas Indian central bank has changed the rate on numerous occasions. As shown in Graph 2 since the talk of tapering of the purchases by US central bank, the yields of US 10 yr Treasury rates have spiked up. This also has led to many steps being taken by the Indian central bank to increase the short term interest rates and eventually the Indian central bank also increased the base rate. This shows a certain degree of limitation to the freedom enjoyed by the Indian central bank in deciding the interest rates in the India. Graph 3 shows the movement of rates of various emerging economies in Asia. The trend of movement is similar across all the countries.
Central banks of emerging economies to a certain extent do not have the ability to control the interest rates in their economies. This is governed to a certain extent by the interest rate movements of key economies globally. One of the choice of the trilema is no longer available with the emerging economies.
Coming to the other two choices, do emerging economy countries have the ability to control exchange rates and ability to allow free movement of capital. Graph 4 shows the movement of the various emerging economies against the US dollar in 2013. Most of the Emerging economies have adopted a floating exchange rate and have given up following a fixed exchange rate policy. As the graph shows, countries do not control the exchange rate however the movement has been highly coordinated with most of them showing a fall vis-a-vis the dollar during the recent times. Countries have given voluntarily given up the ability to control exchange rates. And even if they would like to control the exchange rates, they will not be able to defend the exchange rate in wake of a concentrated global assault against the exchange rate as has been seen historically on numerous occasions. Thus even the second choice of having the ability to control exchange rates is not with emerging economies.
The third choice of allowing free movement of capital, is the only choice that the emerging countries have at the current instance. Emerging economies may not allow full convertibility however to a great extent they allow free capital movement subject to certain limited restrictions. However is this a voluntary choice or is this an involuntary choice. In the current global economy, any emerging economy which would like to impose capital controls would face an instant economic turmoil and would be forced to revoke those restrictions. Hence there is limited freedom for countries to stop free movement of capital.
In essence emerging economies do not have the abilty to control interest rates, do not have the ability to control exchange rate and do not have the ability to control free movement of capital. All these choices are dependent on the actions of other actors globally. Does this mean the trilema is not valid anymore or is this one of the fault line which has emerged?
Graph 2
Graph 3
Graph 4
Graph 1
Graph 1 shows the movement of the US central bank rate and the Indian central bank rate and Graph 2 shows the US 10 yr Treasury yields and the Indian central bank rates.
As illustrated in Graph 1, the Indian central bank rate movements have been in sync with the movement of the US central bank rates for the period from 2000 to 2008. This has been an era of increased movement of capital from developed economies to the emerging economies and an era of very high liquidity in the global markets. Since 2008, US central bank has kept the rates constant whereas Indian central bank has changed the rate on numerous occasions. As shown in Graph 2 since the talk of tapering of the purchases by US central bank, the yields of US 10 yr Treasury rates have spiked up. This also has led to many steps being taken by the Indian central bank to increase the short term interest rates and eventually the Indian central bank also increased the base rate. This shows a certain degree of limitation to the freedom enjoyed by the Indian central bank in deciding the interest rates in the India. Graph 3 shows the movement of rates of various emerging economies in Asia. The trend of movement is similar across all the countries.
Central banks of emerging economies to a certain extent do not have the ability to control the interest rates in their economies. This is governed to a certain extent by the interest rate movements of key economies globally. One of the choice of the trilema is no longer available with the emerging economies.
Coming to the other two choices, do emerging economy countries have the ability to control exchange rates and ability to allow free movement of capital. Graph 4 shows the movement of the various emerging economies against the US dollar in 2013. Most of the Emerging economies have adopted a floating exchange rate and have given up following a fixed exchange rate policy. As the graph shows, countries do not control the exchange rate however the movement has been highly coordinated with most of them showing a fall vis-a-vis the dollar during the recent times. Countries have given voluntarily given up the ability to control exchange rates. And even if they would like to control the exchange rates, they will not be able to defend the exchange rate in wake of a concentrated global assault against the exchange rate as has been seen historically on numerous occasions. Thus even the second choice of having the ability to control exchange rates is not with emerging economies.
The third choice of allowing free movement of capital, is the only choice that the emerging countries have at the current instance. Emerging economies may not allow full convertibility however to a great extent they allow free capital movement subject to certain limited restrictions. However is this a voluntary choice or is this an involuntary choice. In the current global economy, any emerging economy which would like to impose capital controls would face an instant economic turmoil and would be forced to revoke those restrictions. Hence there is limited freedom for countries to stop free movement of capital.
In essence emerging economies do not have the abilty to control interest rates, do not have the ability to control exchange rate and do not have the ability to control free movement of capital. All these choices are dependent on the actions of other actors globally. Does this mean the trilema is not valid anymore or is this one of the fault line which has emerged?
Graph 2
Graph 3
Graph 4
Graph 1
Source of graphs is trading economics web site and Google search
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