The Impossible Trinity – from the Policy Trilemma to the Policy Quadrilemma

The policy Trilemma (the ability to accomplish only two policy objectives out of financialintegration, exchange rate stability and monetary autonomy) remains a valid macroeconomicframework. The financial globalization during 1990s-2000s reduced the weighted average ofexchange rate stability and monetary autonomy. An unintended consequence of financialglobalization is the growing exposure of developing countries to capital flights, and deleveragingcrises. The significant costs associated with these crises added financial stability to the Trilemmapolicy goals, modifying the Trilemma framework into the policy Quadrilemma. Emergingmarkets frequently coupled their growing financial integration with sizable hoarding of reserves,as means of self-insuring their growing exposure to financial turbulences. The global financialcrisis of 2008-9 illustrated both the usefulness and the limitations of hoarding reserves as a selfinsurancemechanism. The massive deleveraging initiated by OECD countries in 2008 mayprovide the impetus for some emerging markets to impose “soft capital controls,†in the form ofregulations that restrain inflows of short terms funds. While modifying the global financialarchitecture to deal with the challenges of the 21th Centaury remains a work in progress, theextended Trilemma framework keeps providing useful insights about the trade-offs andchallenges facing policy makers, investors, and central banks.