Trilemma and Financial Stability Configurations in Asia

Joshua Aizenman
JEL codes: 
ADBI Working Paper Series

This paper takes stock of recent research dealing with the degree to which the trilemma
choices of Asian countries facilitated a smoother adjustment during the global crisis of 2008–
2009, and the way the region has been coping with the adjustment to the postcrisis
challenges. We point out that emerging Asia has converged to a middle ground of the
trilemma configuration: limited financial integration, a degree of monetary independence, and
controlled exchange rate buffered by sizable international reserves. This configuration, with
the proper management of balance sheet exposure and public finances, facilitated a
smoother adjustment of emerging Asia to the crisis, and was instrumental in inducing the
rapid resumption of growth. The swings of financial flows, from large deleveraging of foreign
positions in 2008 to the renewed inflows in 2010, validate the insight of the public finance
approach to financial integration: the gains from deeper financial integration should be
balanced against the costs of growing exposure to turbulences. A key lesson of the crisis is
the need to apply a comprehensive cost/benefit approach to prudential policies, to the
regulation of external borrowing and of domestic financial intermediation, and to the
accumulation and use of international reserves. We illustrate these results in the context of
the challenges facing emerging Asia’s adjustment during the global financial crisis, and the
postcrisis policy stance dealing with the renewed inflows of capital.