ASEAN+4 economies face trilemma trade-offs amid rising global economic volatility

Amid escalating global economic volatility, from U.S. interest rate hikes to fluctuating commodity prices, Asian economies are contending with a policy environment of growing complexity. A new study assesses the vulnerability and resilience of ASEAN+4 countries, revealing how institutional structures and shock typologies mediate the impact of global economic forces on local interest and exchange rates.

The study, titled “Global Risk Factors and Their Impacts on Interest and Exchange Rates: Evidence from ASEAN+4 Economies,” published in the Journal of Risk and Financial Management, uses a structural vector autoregressive model (SVARX) to evaluate nine Asian economies, China, Japan, Korea, Hong Kong, Indonesia, Malaysia, the Philippines, Singapore, and Thailand, between 2010 and 2022. The findings offer a modern empirical lens on the enduring “international finance trilemma”: the theory that countries cannot simultaneously achieve monetary autonomy, exchange rate stability, and capital account openness.

How do exchange rate regimes and capital controls shape monetary autonomy?

The research sorts countries into three categories: floating exchange rate with capital openness (e.g., Korea, Indonesia), fixed exchange rate with capital openness (e.g., Hong Kong), and capital control economies with varying flexibility (e.g., China). Each grouping demonstrates distinct reactions to external shocks.

Countries with floating exchange rates and open capital markets show partial alignment with global interest rate changes. For example, Indonesia and the Philippines responded significantly to U.S. interest rate increases with corresponding domestic rate hikes, aiming to avoid capital flight and stabilize their currencies. However, these responses were not absolute, implying retained, though constrained, monetary policy autonomy.

On the other hand, fixed-rate economies like Hong Kong, operating under a currency board system, exhibited near-total synchronization with U.S. monetary policy. This alignment underscores a trade-off inherent in the trilemma: in preserving exchange rate stability and capital openness, Hong Kong sacrifices monetary independence.

China, with its managed exchange rate and capital control framework, retained notable autonomy. Its short-term interest rate movements were more influenced by domestic inflation and output gaps than by U.S. policy decisions. However, China's exchange rate still displayed sensitivity to global financial stress and oil shocks, suggesting a partial insulation rather than full immunity.

How do different global risk shocks trigger divergent economic responses?

Not all global shocks elicited the same magnitude or direction of response. Among all external forces, U.S. monetary policy shocks emerged as the most dominant, generating the most consistent and statistically significant interest rate responses across the region. Korea, Malaysia, and Indonesia were particularly responsive, whereas Japan’s policy rates remained largely flat, in line with its persistent zero-rate environment.

Oil price shocks, by contrast, produced more heterogeneous effects. Exporting nations like Indonesia and Malaysia experienced exchange rate appreciations, consistent with improved terms of trade. Importing economies, including the Philippines and China, showed currency depreciations and modest rate hikes due to inflationary pressure.

Responses to global financial risk (as proxied by the VIX) and policy uncertainty (via the Global Economic Policy Uncertainty Index) were weaker in terms of interest rate adjustments but more noticeable in exchange rate fluctuations. Japan's yen repeatedly appreciated in these scenarios, reaffirming its status as a safe-haven currency. Meanwhile, other Asian currencies, such as the Philippine peso and Malaysian ringgit, tended to depreciate, revealing vulnerabilities to global capital flow reversals.

Interestingly, shocks related to the Financial Stress Index (FSI) provoked broader and stronger policy reactions than other uncertainty measures. Countries like Hong Kong and Indonesia raised rates sharply to defend financial stability, whereas others, including Malaysia, pursued easing.

What are the broader implications for regional coordination and policy strategy?

The findings validate the core tenets of the international finance trilemma while offering contemporary nuance. Fixed-rate, open-capital economies compromise policy flexibility. Capital control regimes, especially China, preserve greater autonomy, but with caveats. Floating exchange regimes exhibit a middle ground, partial responsiveness, shaped by exposure to capital flows and structural economic features.

Yet beyond formal institutional arrangements, domestic structural factors proved equally decisive. Oil-exporting countries responded differently to commodity shocks than importers. Countries with historically active exchange rate management, such as Malaysia and China, appeared to buffer volatility more effectively. Japan’s behavior across all shocks was anomalous, driven more by its financial role than its regime classification.

The study also emphasizes the strategic role of regional coordination. Given shared exposure but heterogeneous responses, the authors suggest that ASEAN+4 economies could benefit from coordinated policy communication, shared risk monitoring frameworks, and synchronized emergency responses during major external shocks.

While full monetary union is unlikely, increased alignment in macroprudential regulation and capital flow management could serve as first steps toward greater resilience. Moreover, reliance on a one-size-fits-all approach is likely insufficient in an environment where the type of external shock matters as much as the policy regime.