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• 1. [Article] What Matters for Financial Development? Capital Controls, Institutions, and Interactions

  We extend our earlier work, focusing on the links between capital account liberalization, legal and institutional development, and financial development, especially that in equity markets. In a panel data ...

  Citation × Citation Citation Abstract Copy Title: What Matters for Financial Development? Capital Controls, Institutions, and Interactions Author: Chinn, Menzie David, Ito, Hiro Year: 2005 We extend our earlier work, focusing on the links between capital account liberalization, legal and institutional development, and financial development, especially that in equity markets. In a panel data analysis encompassing 108 countries and twenty years ranging from 1980 to 2000, we explore several dimensions of the financial sector. First, we test whether financial openness can lead to equity market development when we control for the level of legal and institutional development. Then, we examine whether the opening of the goods sector is a precondition for financial opening. Finally, we investigate whether a well-developed banking sector is a precondition for financial liberalization to lead to equity market development and also whether bank and equity market development complements or substitutes. Our empirical results suggest that a higher level of financial openness contributes to the development of equity markets only if a threshold level of general legal systems and institutions is attained, which is more prevalent among emerging market countries. Among emerging market countries, a higher level of bureaucratic quality and law and order, as well as the lower levels of corruption, increases the effect of financial opening in fostering the development of equity markets. We also find that the finance-related legal/institutional variables do not enhance the effect of capital account opening as strongly as the general legal/institutional variables. In examining the issue of the sequencing, we find that the liberalization in cross-border goods transactions is found to be a precondition for capital account liberalization. Our findings also indicate that the development in the banking sector is a precondition for equity market development, and that the developments in these two types of financial markets have synergistic effects. Title: What Matters for Financial Development? Capital Controls, Institutions, and Interactions Author: Chinn, Menzie David, Ito, Hiro Year: 2005 We extend our earlier work, focusing on the links between capital account liberalization, legal and institutional development, and financial development, especially that in equity markets. In a panel data analysis encompassing 108 countries and twenty years ranging from 1980 to 2000, we explore several dimensions of the financial sector. First, we test whether financial openness can lead to equity market development when we control for the level of legal and institutional development. Then, we examine whether the opening of the goods sector is a precondition for financial opening. Finally, we investigate whether a well-developed banking sector is a precondition for financial liberalization to lead to equity market development and also whether bank and equity market development complements or substitutes. Our empirical results suggest that a higher level of financial openness contributes to the development of equity markets only if a threshold level of general legal systems and institutions is attained, which is more prevalent among emerging market countries. Among emerging market countries, a higher level of bureaucratic quality and law and order, as well as the lower levels of corruption, increases the effect of financial opening in fostering the development of equity markets. We also find that the finance-related legal/institutional variables do not enhance the effect of capital account opening as strongly as the general legal/institutional variables. In examining the issue of the sequencing, we find that the liberalization in cross-border goods transactions is found to be a precondition for capital account liberalization. Our findings also indicate that the development in the banking sector is a precondition for equity market development, and that the developments in these two types of financial markets have synergistic effects. Close

• 2. [Article] East Asia and Global Imbalances: Saving, Investment, and Financial Development

  We investigate the role of budget balances, financial development and openness, in the evolution of global imbalances. Financial development – or the lack thereof – has received considerable attention ...

  Citation × Citation Citation Abstract Copy Title: East Asia and Global Imbalances: Saving, Investment, and Financial Development Author: Ito, Hiro, Chinn, Menzie David Year: 2008 We investigate the role of budget balances, financial development and openness, in the evolution of global imbalances. Financial development – or the lack thereof – has received considerable attention as a possible contributing factor to the development of persistent and expanding current account imbalances. Several observers have argued that the depth and sophistication of US capital markets have caused capital to flow from relatively underdeveloped East Asian financial markets. In this paper, we extend our previous work by examining the effect of different types and aspects of financial development. Our cross-country analysis, encompassing a sample of 19 industrialized countries and 70 developing countries for the period of 1986 through 2005, yields a number of new results. First, we confirm a role for budget balances in industrial countries when bond markets are incorporated. Second, empirically both credit to the private sector and stock market capitalization appear to be equally important determinants of current account behavior. Third, while increases in the size of financial markets induce a decline in the current account balance in industrial countries, the reverse is more often the case for developing countries, especially when other measures of financial development are included. However, because of nonlinearities incorporated into the specifications, this characterization is conditional upon other factors. Fourth, a greater degree of financial openness is typically associated with a smaller current account balance in developing countries. Title: East Asia and Global Imbalances: Saving, Investment, and Financial Development Author: Ito, Hiro, Chinn, Menzie David Year: 2008 We investigate the role of budget balances, financial development and openness, in the evolution of global imbalances. Financial development – or the lack thereof – has received considerable attention as a possible contributing factor to the development of persistent and expanding current account imbalances. Several observers have argued that the depth and sophistication of US capital markets have caused capital to flow from relatively underdeveloped East Asian financial markets. In this paper, we extend our previous work by examining the effect of different types and aspects of financial development. Our cross-country analysis, encompassing a sample of 19 industrialized countries and 70 developing countries for the period of 1986 through 2005, yields a number of new results. First, we confirm a role for budget balances in industrial countries when bond markets are incorporated. Second, empirically both credit to the private sector and stock market capitalization appear to be equally important determinants of current account behavior. Third, while increases in the size of financial markets induce a decline in the current account balance in industrial countries, the reverse is more often the case for developing countries, especially when other measures of financial development are included. However, because of nonlinearities incorporated into the specifications, this characterization is conditional upon other factors. Fourth, a greater degree of financial openness is typically associated with a smaller current account balance in developing countries. Close

• 3. [Article] Price-based Measurement of Financial Globalization: A Cross-Country Study of Interest Rate Parity

  We characterize the relationship between ex post exchange rate depreciation and the interest differential for a set of countries that spans both developed and emerging market economies. The measured ex ...

  Citation × Citation Citation Abstract Copy Title: Price-based Measurement of Financial Globalization: A Cross-Country Study of Interest Rate Parity Author: Ito, Hiro, Chinn, Menzie David Year: 2007 We characterize the relationship between ex post exchange rate depreciation and the interest differential for a set of countries that spans both developed and emerging market economies. The measured ex post uncovered interest differentials in terms of both levels and absolute values are then related to measures of trade and financial openness, financial development, government budget balances, institutional development, and exchange rate regimes. We find that there is wide diversity in the coefficient relating depreciations and interest differentials. Some of these differing results can be attributed to differences in inflation volatility, financial development, trade openness, capital account openness, legal development, and the nature of the exchange rate regimes. The robust results are mainly found in the developing/emerging market country grouping. Title: Price-based Measurement of Financial Globalization: A Cross-Country Study of Interest Rate Parity Author: Ito, Hiro, Chinn, Menzie David Year: 2007 We characterize the relationship between ex post exchange rate depreciation and the interest differential for a set of countries that spans both developed and emerging market economies. The measured ex post uncovered interest differentials in terms of both levels and absolute values are then related to measures of trade and financial openness, financial development, government budget balances, institutional development, and exchange rate regimes. We find that there is wide diversity in the coefficient relating depreciations and interest differentials. Some of these differing results can be attributed to differences in inflation volatility, financial development, trade openness, capital account openness, legal development, and the nature of the exchange rate regimes. The robust results are mainly found in the developing/emerging market country grouping. Close

• 4. [Article] Current Account Balances, Financial Development and Institutions: Assaying the World “Saving Glut”

  We critically assess several of the key assertions underlying the global saving glut hypothesis. First, we investigate whether the behavior of the U.S. current account behavior is anomalous in light of ...

  Citation × Citation Citation Abstract Copy Title: Current Account Balances, Financial Development and Institutions: Assaying the World “Saving Glut” Author: Chinn, Menzie David, Ito, Hiro Year: 2006 We critically assess several of the key assertions underlying the global saving glut hypothesis. First, we investigate whether the behavior of the U.S. current account behavior is anomalous in light of previous industrial country experience. Second, we determine whether East Asian current account balances are predictable using standard macroeconomic variables, augmented with institutional factors. Finally, we investigate whether higher levels of financial development in key East Asian economies would result in smaller current account surpluses. We find that a one percentage-point increase in the budget balance would increase the current account balance by 0.10 to 0.49 percentage-points for industrialized countries, and that the U.S. current account performance over the last four years is borderline anomalous. While more developed financial markets would lead to smaller current account balances for countries with highly developed legal systems and open financial markets, for key East Asian countries, greater financial development would cause higher saving. Asian current account surpluses seem to be driven by depressed investment, not excess saving. Title: Current Account Balances, Financial Development and Institutions: Assaying the World “Saving Glut” Author: Chinn, Menzie David, Ito, Hiro Year: 2006 We critically assess several of the key assertions underlying the global saving glut hypothesis. First, we investigate whether the behavior of the U.S. current account behavior is anomalous in light of previous industrial country experience. Second, we determine whether East Asian current account balances are predictable using standard macroeconomic variables, augmented with institutional factors. Finally, we investigate whether higher levels of financial development in key East Asian economies would result in smaller current account surpluses. We find that a one percentage-point increase in the budget balance would increase the current account balance by 0.10 to 0.49 percentage-points for industrialized countries, and that the U.S. current account performance over the last four years is borderline anomalous. While more developed financial markets would lead to smaller current account balances for countries with highly developed legal systems and open financial markets, for key East Asian countries, greater financial development would cause higher saving. Asian current account surpluses seem to be driven by depressed investment, not excess saving. Close

• 5. [Article] The Emerging Global Financial Architecture: Tracing and Evaluating New Patterns of the Trilemma Configuration

  This paper investigates how the trilemma policy mix affects economic performance in developing countries. We find that greater monetary independence can dampen output volatility, while greater exchange ...

  Citation × Citation Citation Abstract Copy Title: The Emerging Global Financial Architecture: Tracing and Evaluating New Patterns of the Trilemma Configuration Author: Aizenman, Joshua, Chinn, Menzie David, Ito, Hiro Year: 2009 This paper investigates how the trilemma policy mix affects economic performance in developing countries. We find that greater monetary independence can dampen output volatility, while greater exchange rate stability is associated with greater output volatility, which can be mitigated by reserve accumulation; greater monetary autonomy is associated with higher inflation, while greater exchange rate stability and greater financial openness is linked with lower inflation; pursuit of exchange rate stability can increase output volatility when financial development is at an intermediate stage. Greater financial openness, when accompanied by a high level of financial development, reduces output volatility. Title: The Emerging Global Financial Architecture: Tracing and Evaluating New Patterns of the Trilemma Configuration Author: Aizenman, Joshua, Chinn, Menzie David, Ito, Hiro Year: 2009 This paper investigates how the trilemma policy mix affects economic performance in developing countries. We find that greater monetary independence can dampen output volatility, while greater exchange rate stability is associated with greater output volatility, which can be mitigated by reserve accumulation; greater monetary autonomy is associated with higher inflation, while greater exchange rate stability and greater financial openness is linked with lower inflation; pursuit of exchange rate stability can increase output volatility when financial development is at an intermediate stage. Greater financial openness, when accompanied by a high level of financial development, reduces output volatility. Close

• 6. [Article] Monetary Policy Spillovers and the Trilemma in the New Normal: Periphery Country Sensitivity to Core Country Conditions

  We investigate why and how the financial conditions of developing and emerging market countries (peripheral countries) can be affected by the movements in the center economies - the U.S., Japan, the Eurozone, ...

  Citation × Citation Citation Abstract Copy Title: Monetary Policy Spillovers and the Trilemma in the New Normal: Periphery Country Sensitivity to Core Country Conditions Author: Aizenman, Joshua, Chinn, Menzie David, Ito, Hiro Year: 2015 We investigate why and how the financial conditions of developing and emerging market countries (peripheral countries) can be affected by the movements in the center economies - the U.S., Japan, the Eurozone, and China. We apply a two-step approach. First, we estimate the sensitivity of countries’ financial variables to the center economies [policy interest rate, stock market prices, and the real effective exchange rates (REER)] while controlling for global and domestic factors. Next, we examine the association of the estimated sensitivity coefficients with the macroeconomic conditions, policies, real and financial linkages with the center economies, and the level of institutional development. In the last two decades, for most financial variables, the strength of the links with the center economies have been the dominant factor while the movements of policy interest rate also appear sensitive to global financial shocks around the emerging market crises of the late 1990s and since the global financial crisis of 2008. While certain macroeconomic and institutional variables are important, the arrangement of open macro policies such as the exchange rate regime and financial openness are also found to have direct influence on the sensitivity to the center economies. An economy that pursues greater exchange rate stability and financial openness faces a stronger link with the center economies through policy interest rates and real effective exchange rate (REER) movements. We also find exchange market pressure (EMP) in peripheral economies is sensitive to the movements of the center economies’ REER and EMP during and after the global financial crisis. Open macro policy arrangements, especially exchange rate regimes, also have indirect effects on the strength of financial linkages, interacting with other macroeconomic conditions. Thus, trilemma policy arrangements, including exchange rate flexibility, continue to affect the sensitivity of developing countries to policy changes and shocks in the center economies. Title: Monetary Policy Spillovers and the Trilemma in the New Normal: Periphery Country Sensitivity to Core Country Conditions Author: Aizenman, Joshua, Chinn, Menzie David, Ito, Hiro Year: 2015 We investigate why and how the financial conditions of developing and emerging market countries (peripheral countries) can be affected by the movements in the center economies - the U.S., Japan, the Eurozone, and China. We apply a two-step approach. First, we estimate the sensitivity of countries’ financial variables to the center economies [policy interest rate, stock market prices, and the real effective exchange rates (REER)] while controlling for global and domestic factors. Next, we examine the association of the estimated sensitivity coefficients with the macroeconomic conditions, policies, real and financial linkages with the center economies, and the level of institutional development. In the last two decades, for most financial variables, the strength of the links with the center economies have been the dominant factor while the movements of policy interest rate also appear sensitive to global financial shocks around the emerging market crises of the late 1990s and since the global financial crisis of 2008. While certain macroeconomic and institutional variables are important, the arrangement of open macro policies such as the exchange rate regime and financial openness are also found to have direct influence on the sensitivity to the center economies. An economy that pursues greater exchange rate stability and financial openness faces a stronger link with the center economies through policy interest rates and real effective exchange rate (REER) movements. We also find exchange market pressure (EMP) in peripheral economies is sensitive to the movements of the center economies’ REER and EMP during and after the global financial crisis. Open macro policy arrangements, especially exchange rate regimes, also have indirect effects on the strength of financial linkages, interacting with other macroeconomic conditions. Thus, trilemma policy arrangements, including exchange rate flexibility, continue to affect the sensitivity of developing countries to policy changes and shocks in the center economies. Close

• 7. [Article] Global Current Account Imbalances: American Fiscal Policy versus East Asian Savings

  We consider the origins of global current account imbalances. We first discuss how the expansion of the US current account deficit and the decrease in global real interest rates can be reconciled with ...

  Citation × Citation Citation Abstract Copy Title: Global Current Account Imbalances: American Fiscal Policy versus East Asian Savings Author: Chinn, Menzie David, Ito, Hiro Year: 2007 We consider the origins of global current account imbalances. We first discuss how the expansion of the US current account deficit and the decrease in global real interest rates can be reconciled with the widespread view that American expansionary fiscal policy is partly the source of current trends. We then investigate empirically the medium-term determinants of the current account using a model that controls for factors related to institutional development. In addition to the conventional macroeconomic factors, we examine a series of environmental factors, including the degree of financial openness and the extent of legal development. We find that for industrial countries, the government budget balance is an important determinant of the current account balance; the budget balance coefficient is 0.10 to 0.49 depending on model specifications. These varying estimates lead us to conclude that fiscal factors might be as important as excess savings arising from East Asia. Title: Global Current Account Imbalances: American Fiscal Policy versus East Asian Savings Author: Chinn, Menzie David, Ito, Hiro Year: 2007 We consider the origins of global current account imbalances. We first discuss how the expansion of the US current account deficit and the decrease in global real interest rates can be reconciled with the widespread view that American expansionary fiscal policy is partly the source of current trends. We then investigate empirically the medium-term determinants of the current account using a model that controls for factors related to institutional development. In addition to the conventional macroeconomic factors, we examine a series of environmental factors, including the degree of financial openness and the extent of legal development. We find that for industrial countries, the government budget balance is an important determinant of the current account balance; the budget balance coefficient is 0.10 to 0.49 depending on model specifications. These varying estimates lead us to conclude that fiscal factors might be as important as excess savings arising from East Asia. Close

• 8. [Article] The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma

  This paper extends our previous paper (Aizenman, Chinn, and Ito 2008) and explores some of the unexplored questions. First, we examine the channels through which the trilemma policy configurations affect ...

  Citation × Citation Citation Abstract Copy Title: The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma Author: Aizenman, Joshua, Chinn, Menzie David, Ito, Hiro Year: 2010 This paper extends our previous paper (Aizenman, Chinn, and Ito 2008) and explores some of the unexplored questions. First, we examine the channels through which the trilemma policy configurations affect output volatility. Secondly, we investigate how trilemma policy configurations affect the output performance of the economies under severe crisis situations. Thirdly, we look into how trilemma configurations have evolved in the aftermath of economic crises in the past. We find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. While a higher degree of exchange rate stability could stabilize the real exchange rate movement, it could also make investment volatile, though the volatility-enhancing effect of exchange rate stability on investment can be cancelled by holding higher levels of international reserves (IR). Greater financial openness helps reduce real exchange rate volatility. These results indicate that policymakers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. We also find that the “crisis economies” could end up with smaller output losses if they entered the crisis situation with more stable exchange rates or if they continue to hold a high level of IR and maintain greater exchange rate stability during the crisis period. Lastly, we find that developing countries are often found to have decreased the level of monetary independence and financial openness, but increased the level of exchange rate stability in the aftermath of a crisis, especially for the last two decades. This finding indicates how vulnerable developing countries, especially emerging market ones, are to volatile capital flows as a result of global financial liberalization. Title: The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma Author: Aizenman, Joshua, Chinn, Menzie David, Ito, Hiro Year: 2010 This paper extends our previous paper (Aizenman, Chinn, and Ito 2008) and explores some of the unexplored questions. First, we examine the channels through which the trilemma policy configurations affect output volatility. Secondly, we investigate how trilemma policy configurations affect the output performance of the economies under severe crisis situations. Thirdly, we look into how trilemma configurations have evolved in the aftermath of economic crises in the past. We find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. While a higher degree of exchange rate stability could stabilize the real exchange rate movement, it could also make investment volatile, though the volatility-enhancing effect of exchange rate stability on investment can be cancelled by holding higher levels of international reserves (IR). Greater financial openness helps reduce real exchange rate volatility. These results indicate that policymakers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. We also find that the “crisis economies” could end up with smaller output losses if they entered the crisis situation with more stable exchange rates or if they continue to hold a high level of IR and maintain greater exchange rate stability during the crisis period. Lastly, we find that developing countries are often found to have decreased the level of monetary independence and financial openness, but increased the level of exchange rate stability in the aftermath of a crisis, especially for the last two decades. This finding indicates how vulnerable developing countries, especially emerging market ones, are to volatile capital flows as a result of global financial liberalization. Close

• 9. [Article] A Forensic Analysis of Global Imbalances

  We examine whether the behavior of current account balances changed in the years preceding the global crisis of 2008-09, and assess the prospects for global imbalances in the post-crisis period. Changes ...

  Citation × Citation Citation Abstract Copy Title: A Forensic Analysis of Global Imbalances Author: Chinn, Menzie David, Eichengreen, Barry, Ito, Hiro Year: 2011 We examine whether the behavior of current account balances changed in the years preceding the global crisis of 2008-09, and assess the prospects for global imbalances in the post-crisis period. Changes in the budget balance are an important factor affecting current account balances for deficit countries such as the U.S. and the U.K. The effect of the “saving glut variables” on current account balances has been relatively stable for emerging market countries, suggesting that those factors cannot explain the bulk of their recent current account movements. We also find the 2006-08 period to constitute a structural break for emerging market countries, and to a lesser extent, for industrialized countries. We attribute the anomalous behavior of pre-crisis current account balances to stock market performance and real housing appreciation; fiscal procyclicality and the stance of monetary policy do not matter as much. Household leverage also appears to explain some of the standard model’s prediction errors. Looking forward, U.S., fiscal consolidation alone cannot induce significant deficit reduction. For China, financial development might help shrink its current account surplus, but only when it is coupled with financial liberalization. These findings suggest that unless countries implement substantially more policy change, global imbalances are unlikely to disappear. Title: A Forensic Analysis of Global Imbalances Author: Chinn, Menzie David, Eichengreen, Barry, Ito, Hiro Year: 2011 We examine whether the behavior of current account balances changed in the years preceding the global crisis of 2008-09, and assess the prospects for global imbalances in the post-crisis period. Changes in the budget balance are an important factor affecting current account balances for deficit countries such as the U.S. and the U.K. The effect of the “saving glut variables” on current account balances has been relatively stable for emerging market countries, suggesting that those factors cannot explain the bulk of their recent current account movements. We also find the 2006-08 period to constitute a structural break for emerging market countries, and to a lesser extent, for industrialized countries. We attribute the anomalous behavior of pre-crisis current account balances to stock market performance and real housing appreciation; fiscal procyclicality and the stance of monetary policy do not matter as much. Household leverage also appears to explain some of the standard model’s prediction errors. Looking forward, U.S., fiscal consolidation alone cannot induce significant deficit reduction. For China, financial development might help shrink its current account surplus, but only when it is coupled with financial liberalization. These findings suggest that unless countries implement substantially more policy change, global imbalances are unlikely to disappear. Close

• 10. [Article] Surfing the Waves of Globalization: Asia and Financial Globalization in the Context of Trilemma

  Using the "trilemma indexes" developed by Aizenman et al. (2008) that measure the extent of achievement in each of the three policy goals in the trilemma—monetary independence, exchange rate stability, ...

  Citation × Citation Citation Abstract Copy Title: Surfing the Waves of Globalization: Asia and Financial Globalization in the Context of Trilemma Author: Aizenman, Joshua, Chinn, Menzie David, Ito, Hiro Year: 2009 Using the "trilemma indexes" developed by Aizenman et al. (2008) that measure the extent of achievement in each of the three policy goals in the trilemma—monetary independence, exchange rate stability, and financial openness—this paper examines how policy configurations affect macroeconomic performances with focus on the Asian economies. We find that the three policy choices do not matter for per capita economic growth. However, they do matter for output volatility and the medium-term level of inflation. Greater monetary independence is associated with lower output volatility while greater exchange rate stability implies greater output volatility, which can be mitigated if a country holds international reserves (IR) at a higher level than a threshold (about 20% of gross domestic product). Greater monetary autonomy is associated with a higher level of inflation while greater exchange rate stability and greater financial openness could lower the inflation level. We find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. While a higher degree of exchange rate stability could stabilize the real exchange rate movement, it could also make investment volatile, though the volatility-enhancing effect of exchange rate stability on investment can be cancelled by holding higher levels of IR. Greater financial openness helps reduce real exchange rate volatility. These results indicate that policy makers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. Asian emerging market economies are found to be equipped with macroeconomic policy configurations that help the economies to dampen the volatilities in both investment and real exchange rate. These economies’ sizeable amount of international reserves holding appears to help enhance the stabilizing effect of the trilemma policy choices, which explains the recent phenomenal buildup of international reserves in the region. Title: Surfing the Waves of Globalization: Asia and Financial Globalization in the Context of Trilemma Author: Aizenman, Joshua, Chinn, Menzie David, Ito, Hiro Year: 2009 Using the "trilemma indexes" developed by Aizenman et al. (2008) that measure the extent of achievement in each of the three policy goals in the trilemma—monetary independence, exchange rate stability, and financial openness—this paper examines how policy configurations affect macroeconomic performances with focus on the Asian economies. We find that the three policy choices do not matter for per capita economic growth. However, they do matter for output volatility and the medium-term level of inflation. Greater monetary independence is associated with lower output volatility while greater exchange rate stability implies greater output volatility, which can be mitigated if a country holds international reserves (IR) at a higher level than a threshold (about 20% of gross domestic product). Greater monetary autonomy is associated with a higher level of inflation while greater exchange rate stability and greater financial openness could lower the inflation level. We find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. While a higher degree of exchange rate stability could stabilize the real exchange rate movement, it could also make investment volatile, though the volatility-enhancing effect of exchange rate stability on investment can be cancelled by holding higher levels of IR. Greater financial openness helps reduce real exchange rate volatility. These results indicate that policy makers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. Asian emerging market economies are found to be equipped with macroeconomic policy configurations that help the economies to dampen the volatilities in both investment and real exchange rate. These economies’ sizeable amount of international reserves holding appears to help enhance the stabilizing effect of the trilemma policy choices, which explains the recent phenomenal buildup of international reserves in the region. Close