Home / Opinion / The inescapable trilemma

On 11 February 2014, in her first public appearance as the Federal Reserve chairperson, Janet Yellen told the US Congress that the Federal Reserve shall not be swayed by the happenings in the developing world. Of course, more than her testimony, commentators have pointed to paragraphs in the report that the Federal Reserve presented to the Congress that identify vulnerabilities in emerging economies as the source of the weakness that their currencies and assets have recently faced in financial markets.

Someone needs to remind the new Fed chairperson of this:

“We will conduct all our economic policies cooperatively and responsibly with regard to the impact on other countries and will refrain from competitive devaluation of our currencies and promote a stable and well-functioning international monetary system. We will support, now and in the future, candid, even-handed, and independent International Monetary Fund surveillance of our economies and financial sectors, of the impact of our policies on others, and of risks facing the global economy."

Source: Paragraph 12 of the G-20 Communique after their London meeting in April 2009

This is the context that lends significance to the comment that Raghuram Rajan, governor of the Reserve Bank of India (RBI), made recently. He said that global policy co-ordination between the developed world and the developing world had collapsed. Actually, his remarks were merely a reiteration of the elaborate arguments against unconventional monetary policies of the West he made in the first Andrew Crockett Memorial Lecture in June 2013.

After all, asset purchases by central banks are only one part of their unconventional monetary policy. Their “forward guidance" on interest rates is the second part. It means that interest rates would stay at or around zero per cent well after economic conditions normalize in their countries, in the pretext of insuring an economic recovery. The problem of fickle capital flows into and out of emerging markets is not going to go away.

The real 800-pound gorilla in the room is financial globalization. Financial globalization is the consequence of the naïve extension of the belief that if finance was essential for economic growth, lots of it would ensure faster growth. After three decades of the pursuit of financial globalization, global economies are left with too much finance, too much debt and the prospect of too little growth. Dani Rodrik, in a recent commentary, elaborates more on the harmful consequences of financial globalization and reckons that the answer lies in striking the right balance between the real economy and finance.

Financial globalization has left policymakers in the developing world with few meaningful options. Few years ago, Rodrik coined the phrase, “inescapable trilemma" to make the argument that deep economic integration, democratic politics and nation-states are incompatible. One of the three has to give. He might as well have replaced “deep economic integration" with “financial globalization" because that is what he had in mind when he coined the phrase. The “inescapable trilemma" has reduced the well-known “impossible trinity" in economics to one of impossible policy autonomy. That is, countries cannot have independent monetary policy in a world of unrestricted capital flows regardless of whether they have fixed or floating exchange rates. Therefore, given the reality of financial globalization, market-distorting responses from emerging policymakers may well be inevitable. However, the real worry is that even these second-best options may not be available to them.

In this context, the conference organized by the Centre for Advanced Financial Research and Learning (CAFRAL) in mid-January could not have been timed better. In the conference, Kevin P. Gallagher of the Boston University warned developing countries of the dangers that lurk in the bilateral trade and investment treaties that are thrust on them. He had spelt them out in a paper published in October 2013 in greater detail. The investment clauses in the proposed Trans-Pacific Partnership and other free trade agreements negotiated with the US are based on the 2012 US model bilateral investment treaty (BIT). This does not provide for use of “capital flows management" (CFM) measures in times of crisis.

Where safeguards exist in BIT, they are modelled on standard general agreement on trade in services (GATS) clauses. GATS Article XII provides for adoption of measures in times of “balance of payments" difficulties. But, these are restricted to capital outflows and not inflows. Further, these safeguards must also comply with World Trade Organization norms of being non-discriminatory, temporary and necessary. Finally, the US’s model BIT provides for investor-state dispute settlement rather than confining dispute settlement to between states. The latter would limit the possibility of cases being filed related to sensitive public policies such as CFM.

At the concluding session in the CAFRAL conference featuring three ex-governors of RBI, Bimal Jalan said that the current global monetary regime has no rules of the game and called for a new Bretton Woods agreement. It may take several more crises before more lasting changes occur.

V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at To read V. Anantha Nageswaran’s previous columns, go to

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