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The Future of the International Monetary System

Edited by Marc Uzan

Is the international financial architecture debate over? Not according to leading experts gathered together in this impressive volume who try to identify the key trends that will fashion the international financial system in the years ahead. As history has shown, the evolution of the international monetary system is a slow process. However, the authors argue that we may be entering a new era in which a combination of factors will have lasting consequences on the functioning of the international monetary system and the future role of the IMF.
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Chapter 10: Exchange rates and capital controls in developing countries

Vijay Joshi


* Vijay Joshi What are the implications of financial globalization for exchange rate regimes in developing countries? It is to this question that this chapter is addressed. THE IMPOSSIBLE TRINITY AND THE BIPOLAR VIEW I begin with the well-known trilemma, sometimes referred to as the ‘Impossible Trinity’, to which policymakers in any open economy must respond. A crucial insight of the Impossible Trinity is that the choice of exchange rate regime cannot be considered separately from the choice of policy stance towards capital flows. The standard formulation of the Impossible Trinity says that it is impossible to achieve the following three desirable goals simultaneously: exchange rate stability, capital market integration and monetary autonomy. Any pair of goals is achievable by choosing a suitable payments regime but requires abandoning the third. Specifically: 1. Exchange stability and capital market integration can be combined by adopting a fixed exchange rate but requires giving up monetary autonomy. The authorities lose the power to vary the home interest rate independently of the foreign interest rate. Monetary autonomy and capital market integration can be combined by floating the exchange rate but requires giving up exchange stability. The authorities have the freedom to choose the home interest rate but they must in consequence accept any exchange rate that the market dictates. Exchange stability can be combined with monetary autonomy but requires giving up capital market integration. In the presence of capital controls, the interest rate–exchange rate link is broken. 2. 3. 206 Exchange rates and capital...

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