New Measures of the Trilemma Hypothesis: Implications for Asia

We develop a new set of indexes of exchange rate stability, monetary policy independence, and
financial market openness as the metrics for the trilemma hypothesis. In our exploration, we
take a different and more nuanced approach than the previous indexes developed by
Aizenman, Chinn, and Ito (2008). We show that the new indexes add up to the value two,
supporting the trilemma hypothesis. We locate our sample economies’ policy mixes in the
famous trilemma triangle—a useful and intuitive way to illustrate the state and evolution of policy
mixes. We also examine if the persistent deviation of the sum of the three indexes from the
value two indicates an unsustainable policy mix and therefore needs to be corrected by
economic disruptions such as economic and financial crises. We obtain several findings. First,
such a persistent deviation can occur particularly in emerging economies that later experience
an inflation (or potentially a general or a currency) crisis, and dissipates in the postcrisis period.
Second, there is no evidence for this type of association between deviations from the trilemma
constraint and general, banking, or debt crises. Third, Thailand experienced such a deviation
from the trilemma constraint in the period leading to the baht crisis of 1997, but not other East
and Southeast Asian economies. This last result suggests that the main cause for the Thai baht
crisis was an unsustainable policy mix in the precrisis period, while other affected economies
experienced crises mainly due to contagion from Thailand.