Global Risk Aversion and Capital Flows: An Analysis of the Causes of "Dilemma"

With the development of global financial integration, more and more new factors and mechanisms emerge which influence the effects of monetary policies and traditional framework of "Impossible Triangle". Recently, some scholars proposed a new analytical framework of "Dilemma" which believes that as long as one country allows free capital flow, its monetary policy would not be effective, no matter it adopts floating or fixed exchange rate regime. This paper creatively constructs a new MundeU – Fleming model which contains global risk aversion element. Based on this model, we propose a hypothesis : the increase of global risk aversion will reduce the effect of monetary policy. When the ratio of risk premium caused by global risk aversion and expanded money supply reaches some threshold value, the monetary policy will be completely invalid. We then build a panel data model to conduct empirical test. It strongly confirms the hypothesis mentioned above.