Template-Type: ReDIF-Article 1.0

Author-Name: István Magas
Author-Workplace-Name: Corvinus University of Budapest
Author-Email: istvan.magas@uni-corvinus.hu

Title: Financial Adjustment in Small, Open Economies in Light of the “Impossible Trinity” Trilemma

Abstract: The study examines the resilience of small and open European economies to
external shocks and the various types of financial integration adjustment in an
empirical approach for the period between 1993 and 2016. External financial
integration has been implemented in all of the examined countries, offering
payment channels fully or largely open to foreign countries. The only major
difference was in the level of monetary independence and foreign exchange rate
stability. We were able to differentiate between two types of adjustment: in type
A, financial policy was characterised by a greater level of monetary independence
and a lower level of exchange rate stability, while countries that can be classified
under type B practically gave up their monetary independence with their euro
area membership, and opted for full exchange rate stability. But resilience to
external shocks depends not only on the choices determined by the impossible
trinity, but also on other macro-prudential factors, especially on the stability of
budgetary processes and the repayment of external foreign currency debts. The
difficulty to adjust, transcending beyond the limitations of the “trinity tradeoff”,
was confirmed by the case of Portugal and Greece using the euro as their
local currency, while the example of the non-euro area member Czech Republic
illustrated a traditionally conservative, monetarily independent and successful
external financial adjustment, built on flexible exchange rates and interest spreads.
Hence there were many types of adjustment, where euro area membership in
itself did not mean “bulletproof” protection in every respect. Hungary possibly
joining the euro area would certainly improve its external financial resilience, but
it would not make the existing competitiveness/development deficits disappear.

Classification-JEL: F33, F36, F65
Keywords: monetary policy, shock resilience, exchange rate flexibility
Pages: 5-33
Volume: 17
Issue: 1
Year: 2018
File-URL: http://english.hitelintezetiszemle.hu/letoltes/fer-17-1-st1-magas.pdf
File-Format: Application/pdf
Handle: RePEc:mnb:finrev:v:17:y:2018:i:1:p:5-33