Abstract
The concept of the trilemma has occupied an unassailable place in international macroeconomics ever since the work of Mundell (1960), Mundell (1962) and Fleming (1962). In its simplest form, the concept posits the difficulty an economy with a fixed exchange rate faces in setting its own interest rates, in an environment of an open capital account. Hence, the term “impossible trinity”, which is also used in the literature. To what extent is this assertion valid? Given that endeavours to operate some kind of fixed exchange rate regime have eventually resulted in economic and financial disaster to varying degrees; could the trade-off inherent in the trilemma be the culprit? Empirical tests of the trilemma have, however, yielded results that are not overwhelmingly conclusive. Our aim is to make a contribution to the debate on the relevance of the trilemma, and its relationship with economic performance, by studying a group of emerging market economies. In the first study we employ both pooled data and individual country regressions to test the trilemma. The pooled data results find strong evidence that lends credence to the trilemma, whilst the individual country regressions produce moderate support. Both approaches also find some propensity for the “fear of floating” to exist. In the second study, we first model international macroeconomic arrangements using a system of trilemma archetypes, and then ascertain their relationship with macroeconomic performance, as well as reserves. The results obtained indicate some statistically significant correlation between trilemma archetypes and macroeconomic performance and reserves. The third study, which is an overview of trilemma policies and their effects in the BRIC economies, confirm the trilemma principle to a significant degree, with the exception of a few instances, where the concept is seen not to hold, at least, in the short run.