Author information:
István Magas: BCE World Economy Institute, Instructor, Professor, and doctor of the Hungarian Academy of Sciences. E-mail: istvan.magas@uni-corvinus.hu
Abstract:
The study examines the resilience of small and open European economies to external shocks and the various types of financial integration adjustment in an empirical approach for the period between 1993 and 2016. External financial integration has been implemented in all of the examined countries, offering payment channels fully or largely open to foreign countries. The only major difference was in the level of monetary independence and foreign exchange rate stability. We were able to differentiate between two types of adjustment: in type A, financial policy was characterised by a greater level of monetary independence and a lower level of exchange rate stability, while countries that can be classified under type B practically gave up their monetary independence with their euro area membership, and opted for full exchange rate stability. But resilience to external shocks depends not only on the choices determined by the impossible trinity, but also on other macro-prudential factors, especially on the stability of budgetary processes and the repayment of external foreign currency debts. The difficulty to adjust, transcending beyond the limitations of the “trinity trade-off”, was confirmed by the case of Portugal and Greece using the euro as their local currency, while the example of the non-euro area member Czech Republic illustrated a traditionally conservative, monetarily independent and successful external financial adjustment, built on flexible exchange rates and interest spreads. Hence there were many types of adjustment, where euro area membership in itself did not mean “bulletproof” protection in every respect. Hungary possibly joining the euro area would certainly improve its external financial resilience, but it would not make the existing competitiveness/development deficits disappear.
Cite as (APA):
Magas, I. (2018). Financial Adjustment in Small, Open Economies in Light of the “Impossible Trinity” Trilemma. Financial and Economic Review, 17(1), 5–33. https://doi.org/10.25201/FER.17.1.533
Column:
Study
Journal of Economic Literature (JEL) codes:
F33, F36, F65
Keywords:
monetary policy, shock resilience, exchange rate flexibility
References:
Aizenman, J. (2010): The Impossible Trinity (aka The Policy Trilemma). Working Paper Series from Department of Economics, UC, Santa Cruz. https://cloudfront.escholarship.org/dist/prd/content/qt9k29n6qn/qt9k29n6qn.pdf. Downloaded: 31 August 2017.
Aizenman, J. – Chinn, M. D. – Ito, H. (2013): The “Impossible Trinity” Hypothesis in an Era of Global Imbalances: Measurement and Testing. Review of International Economics, 21(3): 447–458. https://doi.org/10.1111/roie.12047
Bohl, M. T. – Michaelis, P. – Siklos, P. L. (2016): Austerity and recovery: Exchange rate regime choice, economic growth and financial crises. Economic Modelling, Vol. 53: 195–207. https://doi.org/10.2139/ssrn.2696440
Bruno, M. – Di Tella, G. – Dornbusch, R. – Fisher, S. (1988): Inflation Stabilization: The Experience of Israel, Argentina, Brazil, Bolivia, and Mexico. Cambridge, Mass: MIT Press.
Cecchetti, S.G. – King, M.R. – Yetman, J. (2011): Weathering the Financial Crisis: Good Policy or Good Luck? BIS Working papers 351.
Chinn, M. D. – Ito, H. (2008): A New Measure of Financial Openness. Journal of Comparative Policy Analysis, 10(3): 309–322. https://doi.org/10.1080/13876980802231123
Fisher, S. (2010): Myths of Monetary Policy. Israel Economic Review, 8(2): 1–5.
Fleming, J. M. (1971): Domestic Financial Policies Under Fixed and Floating Exchange Rates. In J. M. Fleming, Essays in International Economics (Cambridge, Mass.: Harvard University Press, 1971), chpt. 9., Reprint. First published as: “Domestic Financial Policies Under Fixed and Under Floating Exchange Rates”, International Monetary Fund Staff Papers, 9 (November 1962).
Gros, D. – Mayer, T. (2010): How to Deal with Sovereign Defaults in Europe: Towards a Euro(pean) Monetary Fund. http://www.europarl.europa.eu/document/activities/cont/201003/20100309ATT70196/20100309ATT70196EN.pdf
International Monetary Fund (2015): World Economic Outlook—Update. Washington DC, January 19.
Kenen, P. B. (1989): The International Economy. Second Edition. Englewood Cliffs, NJ: Prentice Hall. Chpt. 15, pp. 313–328.
Krugman, P. (1987): Target Zones and Exchange Rate Dynamics. Quarterly Journal of Economics, 106(3): 669–682. https://doi.org/10.2307/2937922
Lehmann, K. – Palotai, D. – Virág, B. (editor) (2017): The Hungarian Way – Targeted Central Bank Policy. Magyar Nemzeti Bank, Budapest.
Mundell, R. A. (1961): A Theory of Optimum Currency Area, The American Economic Review, 51(4): 657–665.
Mundell, R. A. (1968): Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates. Reprinted In: International Economics, New York: Macmillan, pp. 250–271.
Neményi, J. – Oblath, G. (2012): Az euro hazai bevezetésének újragondolása (Reconsidering the Hungarian introduction of the euro). MTA KRTH Workshop Studies, MT-DP – 2012/14.
Oblath, G. (2016): Működőtőke-áramlás, újrabefektetett jövedelem és a nettó külföldi vagyon változása Magyarországon (Flow of working capital, reinvested income and changes in net foreign wealth in Hungary). Statisztikai Szemle, 94(8–9): 821–855.
Obstfeld, M. (2015): Trilemmas and trade-offs: living with financial globalisation. BIS Working Papers, No. 480.
O’Neill, J. (2001): Building Better Global Economic BRICs. GS Global Economics Paper, No. 66.
Rojas-Suarez, L. (2015): Emerging Market Macroeconomic Resilience to External Shocks: Today versus Pre–Global Crisis. Center for Global Essay, https://www.cgdev.org/sites/default/files/CGD-Essay-Rojas-Suarez-Emerging-Market-Macroeconomic-Stability_0.pdf. Downloaded: 17 August 2017.
Shambaugh, J. C. (2004): The Effect of Fixed Exchange Rates on Monetary Policy. The Quarterly Journal of Economics, 119(1): 301–352. https://doi.org/10.1162/003355304772839605
Vígvári, G. (2013): Gazdasági kormányzás a gazdasági és monetáris unióban – a globális politika lehetetlen szentháromsága szemszögéből. (Economic governance in the economic and monetary union from the perspective of the impossible trinity of global policy) Köz-gazdaság, 8(1): 129–138.
CEPS Policy Brief 202. Institute of International Finance, 2015, “Capital Flows to Emerging Markets”, January 15.