NOTE:
This paper is currently under peer review to be published in an International Journal in Europe this year, 2024. This document is embargoed until published.
Abstract
There has been a concerted debate about the sensitivity of the Trilemma Index to economic and financial activities. The literature suggests that when it comes to macroeconomic management, policymakers must compromise by choosing two, rather than all, of the three policy options: monetary independence, exchange rate stability, and financial openness. This is the famous hypothesis in international finance called the trilemma or the impossible trinity. Our main concern is which selection from the Trilemma Index influences the development of financial institutions and markets as well as investments in developing countries, especially in Africa. This study extends the empirical method to study the Trilemma Index and the evolution of financial institutions in Africa. Using ordinary least squares, two-stage least squares, and two-stage Generalized Method of Moments (GMM) estimator techniques with a dataset covering a range of 44 African countries over an extended period of 30 years, we point to monetary independence and financial market openness policies are the best indices that have a significant positive impact on the development of financial institutions in Africa. The main reason is that most African countries do not have well-developed financial institutions and are unable to control exchange rate stability. The author concluded that the financial openness of countries is the best tool for access to financial markets and efficiency in African markets. We note that the effect of the Trilemma Index on investments in Africa remains a major challenge to control. The main reason is that most African countries do not have well-developed monetary policies and autonomy and rely on foreign direct investment (FDI). On the other hand, they do not have enough capacity to control exchange rate stability. The endogeneity tests support our results. We recommend that government or central banks carefully consider exchange rate flexibility decisions as exchange rate flexibility has real financial implications for the African market.
The Effect of Impossible Trinity on Investment in Developing Countries
We analyze the effect of the impossible Trinity on investments using African data. The focus is on the trilemma index, financial market efficiency, access to finance, summary statistics, empirical results and discussions, endogeneity issues, and the second partial conclusion.
