Monetary Policy Independence In The “trilemma??

According to the 14 th Five-Year Plan and the vision for 2035,China will accelerate the formation of a new development pattern of “Dual Circulation”.Under the “Dual Circulation”,China will make full use of the advantages of a large domestic market,continue to expand the high-level financial opening-up,and further strengthen the flexibility of the RMB exchange rate system.The coordination of these tasks involves a deep understanding of the “Trilemma” and a reasonable choice of relevant policy arrangements.Prudent monetary policy aims to promote the economy growth and balance internal and external equilibrium.Regarding the “Dual Circulation”,the role of domestic market will be significantly enhanced,and thus put forward higher requirements for maintaining the independence of monetary policy.Based on the above background,combined with theoretical analysis and empirical analysis,this paper focuses on three policy objectives of the “Trilemma”: free capital flow,monetary policy independence and exchange rate stability.Firstly,regarding the free capital flow,this paper examines the dynamic effect of capital controls on monetary policy independence.Secondly,focusing monetary policy independence,this paper investigates periphery countries’ potential heterogeneous responses to international monetary shocks based on domestic inflation.Finally,focusing on the exchange rate system,this paper studies the effect of exchange rate floating against monetary policy shocks,and further explores the macroeconomic performance of the combination of“intermediate policies”.On the theoretical level,the research of this paper is helpful to enrich the research perspectives of the “Trilemma”,further develop the standard open economy theoretical model and provide empirical evidence.On the practical level,the research of this paper provides policy implications for resisting the monetary policy shocks and maintaining domestic monetary policy independence.The main conclusions are as follows: first,this paper studies the dynamic impact of capital controls on monetary policy independence,focusing on the heterogeneous impact in the short and long term.The results show that capital controls can effectively help maintain the monetary policy independence in the short run,but the effect is not significant in the long run.As long as the interest rate difference between the two countries exists,capital controls cannot change the investment willingness of investors,thus the driving force of international capital flow is always there.International capital investors seek ways to circumvent capital controls,weakening capital controls’ effect on monetary policy independence in the long run.Therefore,in terms of providing monetary policy independence,the effect of capital controls is significant in the short run,but not significant in the long run.In addition,the heterogeneity test of different exchange rate regimes shows that capital controls combined with a relatively flexible exchange rate regime can better maintain the monetary policy independence.This is because moderate exchange rate fluctuations can reduce the passive monetary policy required to maintain a fixed exchange rate regime.Second,this paper investigates the heterogeneous responses of peripheral countries to monetary policy shocks based on their own inflation levels.The results show that periphery countries’ monetary policy autonomy is subject to their own inflation.When the center country increases interest rate,periphery countries with high inflation are more willing to follow while the ones with low inflation are reluctant to do so,and vice versa.Besides,this paper finds that periphery countries’ monetary policy autonomy is enhanced by flexible exchange regimes or capital controls,consistent with the trilemma hypothesis.Third,this paper examines the effect of exchange rate flexibility against monetary policy shocks.It is found that fixed exchange rate regime or pegged exchange rate regime cannot resist monetary policy shocks,while managed floating exchange rate regime and floating exchange rate regime can resist monetary policy shocks.It is worth noting that exchange rate fluctuations cannot resist previous monetary policy shocks from the central country.The possible reason is that in addition to the money market and commodity market channels for monetary policy shock transmission,there are other channels: “credit channel” and “risk taking channel”.The expansionary monetary policy of the central country can affect the interest rate of other countries through the global credit market.Therefore,exchange rate fluctuations cannot always resist the monetary policy shocks of the central country.In addition,heterogeneous study shows that under the condition of free capital flow,exchange rate flexibility cannot resist the monetary policy shocks.However,the policy combination of exchange rate flexibility and capital control can effectively resist monetary policy shocks from the central country.Fourth,this paper studies the macroeconomic performance of “intermediate policy” and its combination.It is found that compared with fully floating exchange rate system,maintaining a certain degree of exchange rate stability is conducive to steady economic growth and moderate inflation.However,the correlation between capital flows and economic fluctuations is not clear.In addition,foreign exchange reserves help reduce economic fluctuations.The combination of“intermediate policy” helps mitigate external shocks and reduce output volatility.The contribution of this paper is mainly in the following two aspects: on one hand,the study of this paper provides new perspectives for relevant research of the “Trilemma”.First,Chapter two studies the dynamic impact of capital controls on monetary policy independence.Since previous studies on the “Trilemma” focus on static state,this paper tries to add a time dimension to the “Trilemma”,which provides a new perspective for the related research on the impact of capital control on monetary policy independence.Second,previous literature regarding the convergence of monetary policy interest rates as peripheral countries being“forced” to follow the changes of monetary policy interest rates of central countries.However,from the perspective of the potential “initiative” of peripheral countries,Chapter four studies the heterogeneous response of peripheral countries based on their own inflation level.Chapter four provides a new perspective to study interest rate shock transmission,interest rate convergence and other related issues,making relevant research more comprehensive.Third,there are relatively few studies on the combination of “intermediate policies”.This paper studies the effects of the combination of “intermediate policies” on resisting monetary policy shocks,maintaining monetary policy independence and promoting stable economic growth,thus enriching the research on the related issues of the “Trilemma” policy choices.On the other hand,the research of this paper extends the standard open economy theoretical model.First,Chapter two incorporates capital controls and the behavior of international investors to avoid capital controls into the standard small open economy model,and expounds the long-and short-term differences of the impact of capital controls on the monetary policy independence.Second,Chapter four constructs the loss function of the central banks of peripheral countries,incorporating the inflation target,and expounds the heterogeneous response of peripheral countries to monetary policy shocks based on their own inflation.This paper enriches the standard open economy model and improves the research on related issues.