The impossible trinity
The ‘trilemma’ has become a topic of discussion after the recent increase in interest rates by the US Federal Reserve to counter rising prices.
- The Impossible Trinity, or ‘trilem’, refers to the idea that an economy cannot, at the same time, ‘follow independent monetary policy, maintain a fixed exchange rate, nor allow free flow of capital across its borders.
- According to economists, an economy can choose to adopt only two of the three policy options mentioned above simultaneously in the long run.
- The idea was proposed independently by Canadian economist Robert Mundell and British economist Marcus Fleming in the early 1960s.
- Since capital is largely free to move across borders, policy makers have a choice between maintaining a fixed exchange rate and following an independent monetary policy.
- On the other hand, if the policy makers of a country choose to adopt ‘independent monetary policy’, they may not be able to maintain the foreign exchange value of their currency at the desired level.
With reference to India:
The Reserve Bank of India may also be faced with the dilemma of choosing between maintaining the ‘price of the rupee’ and maintaining its ‘monetary policy independence’. As, with the US Federal Reserve raising interest rates, there is increasing pressure on the rupee, and the ‘price of the rupee’ has depreciated by almost 10% against the US dollar this year.
Source – The Hindu
