The course ends by zooming out to the deepest constraint on a small open economy: the global financial cycle and the dominance of the dollar. The uncomfortable conclusion of recent research is that a developing economy's room for manoeuvre is even more limited than the trilemma suggests — it is buffeted by a global cycle it cannot control and denominated in a currency it does not issue. Understanding this is essential to judging African monetary and exchange-rate policy fairly.
The global financial cycle
Dilemma, not trilemma (Rey 2015)
Hélène Rey's influential argument: there is a global financial cycle — a common factor driving capital flows, asset prices, credit growth, and leverage across the whole world, largely synchronised and driven by global risk appetite (often proxied by the VIX 'fear index') and, crucially, by US monetary policy. When the Fed loosens and risk appetite is high, capital floods into the periphery, credit booms, and asset prices rise everywhere; when the Fed tightens and risk-off hits, capital retreats and credit contracts globally. Rey's radical implication: this global cycle means the trilemma is really a DILEMMA. The trilemma said a floating exchange rate buys you monetary independence (you can choose your own interest rate if you let the currency float). Rey argues that is too optimistic: because the global financial cycle transmits financial conditions across borders regardless of the exchange-rate regime, even a country with a floating currency does NOT have full monetary independence as long as its capital account is open — the global cycle imposes itself anyway. So the real choice is a dilemma: either restrict the capital account (manage capital flows) OR accept that your financial conditions are partly set abroad, regardless of whether you float. Floating is not the escape from the global cycle that the trilemma promised.
The dominance of the dollar
The dominant-currency paradigm (Gopinath)
The international monetary system is not symmetric — it is dollar-centric. Gita Gopinath's 'dominant currency paradigm' documents that a huge share of world trade is invoiced and settled in dollars, even trade not involving the US (a Kenyan importer buying from China often pays in dollars). The consequences are profound: a country's import prices depend on the dollar exchange rate, not just on the bilateral rate with its trading partner, so dollar appreciation raises import prices for everyone; the exchange-rate-expenditure-switching mechanism (a depreciation boosting exports) works far more weakly than the textbook assumes, because export prices are sticky in dollars; and the US enjoys an 'exorbitant privilege' (it borrows in its own currency, and the dollar's safe-haven status means capital flows TO the US in crises — the opposite of the periphery). The dollar's dominance means the global financial cycle is largely a DOLLAR cycle: US monetary policy and the dollar's value drive financial conditions worldwide, and developing economies are price-takers in a system organised around a currency they do not issue.
US-rate spillovers
The practical face of all this is the spillover of US monetary policy to the periphery. When the Fed signals tightening, the effects ripple out forcefully: the dollar strengthens (raising the burden of dollar-denominated debt — the Eurobond and currency-mismatch problems of the earlier modules), capital flows out of emerging and frontier markets back to higher-yielding, safer US assets (the sudden-stop trigger), spreads widen, and frontier currencies depreciate. The 2013 'taper tantrum' (when the Fed merely hinted at slowing its asset purchases) and the 2022 hiking cycle both showed this vividly — the latter producing the frontier-market lockout, debt distress, and currency pressures that recur throughout this specialization. A developing economy can be doing everything right domestically and still be hit hard by a decision made in Washington for purely US reasons. The spillover is the mechanism through which the global financial cycle and dollar dominance actually bite.
What policy space remains?
If the periphery is buffeted by a global cycle it cannot control and denominated in a currency it does not issue, what can it actually do? The honest answer: less than the textbook implies, but not nothing. The realistic toolkit (drawing the whole specialization together): build buffers (adequate FX reserves as self-insurance against sudden stops, module 6); reduce vulnerabilities (limit foreign-currency debt and currency mismatch — escape original sin; develop local-currency markets — the Sovereign Debt course); use capital-flow management to lean against destabilising surges (module 5); maintain sound fundamentals and credibility (to stay in the good equilibrium and not give the global cycle extra reasons to punish you — the crisis modules); deepen domestic financial markets (so transmission works and the economy is less dependent on foreign capital); and pursue structural transformation to ease the external constraint (diversify exports — the Trade and Development courses). And collectively, developing economies push for reforms to the international architecture (a better global financial safety net, swap lines, a faster debt-restructuring framework, a less dollar-dependent system) — the agenda of African economic diplomacy. The deepest lesson of the course is one of calibrated humility: a small open economy's macroeconomic fate is substantially shaped by forces beyond its borders and its control, so its policy should focus on resilience and reducing vulnerability rather than on a monetary autonomy it does not fully possess — and it should be judged against that reality, not against a textbook written for the country that issues the world's currency.
Exercise
An African frontier economy with a floating currency, an open capital account, sound fundamentals, and significant dollar-denominated debt is hit hard when the US Federal Reserve begins an aggressive hiking cycle: its currency falls 30%, capital flows out, its spread blows out, and credit tightens — despite no change in its own policies. (1) Explain why 'floating' did not insulate it, using Rey's dilemma. (2) Explain the role of dollar dominance in the severity of the shock. (3) Explain why the country's sound domestic policy didn't protect it. (4) What could the country realistically have done beforehand, and what does this imply about how to judge its policymakers?