Financial market integration has contributed to risk-sharing through portfolio diversification and has provided a positive effect on economic growth by supplying funds to countries that lack capital. At the same time, however, it has caused the negative spillovers of financial shocks through the integrated financial markets. A typical example is the 2008 global financial crisis. As the uncertainties in the global financial market increase significantly during the crisis period, financial variables (asset price, leverage, credit growth, capital flows, etc.) in developed and emerging economies are not controlled by their own monetary policies, but are more sensitive to global financial market sentiments. In the end, it has greatly restricted monetary policies in many countries. In this study, we investigate on how much monetary policies have been restricted by constructing a monetary policy independence index, and try to understand monetary policy independence by trilemma, which is a main implication from the Mundell-Fleming model.
  According to trilemma, a country cannot achieve three policy goals simultaneously, i.e., one policy goal must be abandoned to achieve two. The three policy goals are exchange rate stability, capital account openness, and monetary policy independence. If trilemma holds, monetary policy independence can be secured by abandoning the stable exchange rate through adoption of floating exchange rate system in the open capital market. In order to see whether such monetary policy independence is indeed consistent with what trilemma predicts, we constructed the trilemma Index using data from 2002 to 2013 that covers 45 countries including Korea. The trilemma indexes consist of monetary policy independence index, capital account openness index, and exchange rate stability index. short-term interest rate independence index, which reflects the tendency of short-term interest rate desynchronization, is constructed to evaluate monetary policy independence.
  The monetary policy independence means the autonomy of short- term policy rate decision in narrow definition, but broadly it means the capacity to pursue domestic policy goals. In order to evaluate various aspects of monetary policy independence in this paper, we use not only short-term policy rate used in the construction of the short-term interest rate independence index, but also the long-term interest rate that plays an important role in the monetary transmission mechanism. In the transmission mechanism, short-term policy rate decisions lead to changes in various interest rate variables, particularly long-term interest rates that in turn affect the economic performance such as investment and output. However, if the short-term policy rate does not affect long-term interest rate, the effect of monetary policy independence on the real sector is reduced. In order to take this possibility into consideration, we will construct a long-term interest rate independence index (LRI) reflecting the tendency to long-term interest rate desynchronization, and analyze the economic implications of this new index.
  The results of the analysis show that we have found trade-offs among three trilemma indexes and this supports that trilemma holds. However, when we consider for the long-term interest rate independence index instead of short-term interest rate independence index to evaluate the monetary policy independence broadly, it could be seen that not trilemma but, dilemma holds. This is particularly noticeable during periods when the correlation between the two indexes has weakened since the global financial crisis. Given the stylized fact we found that the long-term interest rate independence index is a very important explanatory variable in explaining the international business cycle especially after the global financial crisis, we need to closely monitor the long-term interest rate independence index.
  In the Block-Exogenous vector autoregression (VAR) model, we examine the impact of the US short-term interest rate shock on the short- and long-term interest rates in 10 emerging market economies. The empirical results show that there is a short-term interest rate synchronization, but no long-term interest rate synchronization before the global financial crisis. Since the global financial crisis, however, there is only long-term interest rate synchronization even without short-term interest rate synchronization. This is consistent with the results of the analysis using the long-term interest rate independence index. In the empirical result of the extended VAR analysis in which high and low capital account openness country group are separately considered, we found that the long-term interest rate synchronization is more pronounced in the country with high capital account openness, which implies that the capital control or the macroprudential policy can be useful policy measures to manage the long-term interest rate synchronization.
  In the case of Korea, capital account openness index increased significantly after the global financial crisis, while vulnerability remained high in terms of exchange rate stability index. Although the short-term interest rate independence index was highly evaluated, the long-term interest rate independence index fell sharply after the global financial crisis. The impact of the US short-term interest rate shocks on short- and long-term interest rates in Korea was similar to the impulse response function of the above 10 emerging market economies. It is necessary to pay attention to the results of empirical analysis using high and low capital account openness country group. This suggests a new perspective on the role of capital control or macrprudential policy measures in relation to monetary policy independence. These policy tools have been so far mainly discussed in the context of capital flow management, but our empirical results show that these policy tools can be also useful to secure monetary policy independence for emerging market economies.