Monetary independence and liberalisation of capital flows: an unattainable duo in the context of financial globalisation and eurozone accession?

Abstract

Aim: Financial globalisation is a process that involves the liberalisation of capital flows and the deregulation of financial markets. Under these conditions, however, financial crises are more easily transmitted between countries, and the issue of financial stability is once again gaining topicality, with independent monetary policy playing an important role. The aim is to define the concept and meaning of monetary policy independence and to examine whether it is possible to achieve a certain degree of independence.

Methods: Through a critical analysis of the theoretical concepts of “trilemma”, “quadrilemma” and “dilemma” and an insight into the “original sin hypothesis” in previous research, the interrelationship between monetary policy, capital flows and exchange rate regimes was explained to form an empirical research model. The study was conducted for a group of six Central and Eastern European (CEE) countries. A dynamic panel model was used in which monetary policy independence is estimated by the β1 coefficient. The higher the coefficient with the Euro Interbank Offered Rate (EURIBOR), i.e. the closer its value is to 1, the greater the influence of foreign interest rate movements on the domestic interest rate and the lower the country's degree of monetary policy independence.

Results: The coefficient β1 with the EURIBOR variable was 0.72 and was statistically significant at all significance levels, which means that there was a significant transmission of the foreign interest rate to the domestic interest rate in the observed countries and the degree of monetary policy independence is low.

Conclusions: Financial openness affected the reduction and accumulation of reserves, the growth of the degree of monetary policy independence, while the choice of exchange rate regime was not statistically significant. The study thus confirms that monetary policy independence in the era of capital account liberalisation is limited regardless of the type of exchange rate regime.