Exchange rate flexibility and monetary policy autonomy: a reality or an illusion? Econometric test of the Mundell−Fleming trilemma in the context of emerging countries

Purpose This paper aims to assess the degree to which flexibilization of the exchange rate regime can be an optimal option for achieving monetary policy autonomy. This could only be attained by putting the revelations of Mundell’s trinity under econometric examination in the context of emerging countries. Design/methodology/approach The methodology unfolds in three complementary stages. First, the authors assess the degree of monetary policy autonomy in each country by estimating the dynamic correlation between domestic interest rates and the US federal funds rate using the DCC-GARCH models. This provides a time-varying measure of the sensitivity of domestic interest rates to external monetary shocks. In the second stage, ANOVA and Bartlett’s tests are used to determine whether monetary policy autonomy differs significantly across exchange rate regimes. Finally, in the third stage, the authors estimate a random-effects panel model incorporating the three pillars of the Mundell trilemma (monetary policy autonomy, exchange rate regime and capital account openness) to provide a comprehensive empirical assessment of their interactions within emerging economies. Findings This study provides empirical evidence that no country is immune to the “Soft Power” exerted by US interest rates on the monetary conditions of peripheral countries. However, flexible exchange rate regimes provide relative autonomy for monetary policy by reducing the impact of capital account openness on the sensitivity of domestic interest rates in emerging countries. Originality/value While monetary policy autonomy has been the subject of extensive research, its measurement still relies largely on indirect or institutional indicators whose ability to accurately reflect the degree of autonomy actually exercised remains a matter of debate. The originality of this study therefore lies in a two-step approach: first, constructing an empirical measure of the actual degree of monetary policy autonomy rather than relying on a preexisting indicator; and second, analyzing the determinants of this autonomy within the framework of Mundell’s “impossible trinity.” This approach addresses a methodological gap in the literature by placing the measurement of monetary policy autonomy itself at the center of the empirical analysis.