In a landmark 2015 paper provocatively titled “Dilemma Not Trilemma”, Hélène Rey argued that the policy space for small open economies does not, after all, afford a choice, given open capital accounts, between exchange rate stabilization and monetary policy independence. The bulk of the paper documents a global financial cycle under which capital flows, credit, leverage, and asset prices all move in sync across international boundaries. It is then taken on faith that with such ebbs and flows of finance washing around, the only way to carve out space for independent monetary policy is through capital controls or, in a more evolved spirit, macroprudential measures. Any empirical examination of the interplay between the exchange rate and monetary policy under the classic trilemma was beyond the scope of the paper.
A perspective on the global financial cycle from the domestic side of a small open economy was presented by Assistant Governor of the Bangko Sentral ng Pilipinas Margarita Debuque-Gonzales at our ACAES session at the 2026 Allied Social Science Association Annual Meeting. Debuque-Gonzales identified periods of disconnect between short-run market rates of interest and the central bank policy rate in association with foreign capital flows into the Philippines. Applying a Markov-switching model, she showed that under global risk-on conditions, inflows of foreign capital drove the Philippine treasury-bill rate down below the policy rate to undermine monetary policy transmission. With the switch to risk-off conditions, short-term rates reconnected to the policy rate. The key insight is that applicability of the trilemma is state dependent.
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