Economics Working Paper 18121
Abstract: This paper explores the problem of adjustment to the challenges of globalization in terms of the logic underpinning four distinct policy tradeoffs or trilemmas, and their interrelationship, and in particular the disturbances that arise from capital controls. The trilemmas depict the way that domestic monetary, financial, economic and political systems are interconnected with the international. They can be described as the impossible policy choices at the heart of globalization. The analysis of a policy trilemma was developed first as a diagnosis of exchange rate problems (the incompatibility of free capital controls with monetary policy autonomy and a fixed exchange rate regime); but the approach can be extended. The second trilemma we describe is the incompatibility between financial stability, capital mobility and fixed exchange rates. The third example extends the analysis to politics, and looks at the strains in reconciling democratic politics with monetary autonomy and capital movements. Finally, we examine the security aspect and look at interactions of democracy with capital flows and international order. Frequently, the trilemmas conjure up countervailing anti-globalization tendencies and trends. In today’s world are the alternatives to capital driven globalization—in the form of either Trumpian economic nationalism or Xi’s infrastructure driven globalization—dangerous enough to promote a rethinking of the tradeoff between the benefits of interconnectedness and the related destabilizing volatility?