The Monetary Trilemma Need Not Hold in the Short Run: The Case of Hong Kong

Abstract

The monetary trilemma autonomy has been at the heart of a great deal of international monetary analysis. It implies that countries with fixed exchange rates and no capital controls will lose monetary autonomy. What is often not recognized, however, is that the trilemma need not hold in the short run. If capital mobility is less than perfect, then countries can sterilize reserve flows and maintain a degree of monetary autonomy in the short run. Hong Kong has perfect conditions for the trilemma to hold even in the short run. It is a small open economy with a fixed exchange rate and no major capital controls. If the trilemma does not hold for Hong Kong in the short run, then it is likely to not hold for many other countries either. We investigate this issue using two approaches. One is to estimate the effects of changes in US interest rates on those in Hong Kong. As with earlier literature, we find that the pass-through is substantially less than one, indicating imperfect capital mobility. The second is to estimate whether Hong Kong has been able to engage in some degree of sterilization. The Hong Kong Monetary Authority uses a measure of the monetary base that differs from the standard International Monetary Fund definition. We test both measures and find evidence of partial sterilization of international reserve flows. These tests indicate that Hong Kong does have a degree of short-term monetary autonomy.