Impossible Trinity - In Today's Context

The impossible trinity also known as the monetary trilemma is a concept in international economics which states that it is impossible to have all three of the following at the same time.

It's basically representing a relationship between three economic goals -

• Exchange rate stability

• Monetary Policy Autonomy

• Free Capital Movement

Let's first understand the three goals -

• Exchange Rate Stability - This means keeping the value of your currency steady relative to other currencies. It's like trying to keep the price of your favorite snack the same, even as prices of other snacks change. There are multiples way to do it.
  

• Monetary Policy Autonomy - This refers to the ability of a country's central bank to control its own money supply and interest rates. It's like having the power to adjust the amount of money you have in your reserves or the interest rate on your savings account.
  

• Free Capital Movement - This means allowing money to flow in and out of your country without restrictions. It's like letting people come and go freely from your neighborhood without any gates or barriers.

Now, here's the catch:

You can only achieve two out of these three goals at the same time. It's like trying to balance on a three-legged stool where you can't have all legs firmly on the ground at once.

• If you prioritize exchange rate stability and free capital movement, you have to give up control over your monetary policy. This means you can't adjust interest rates or print more money as needed because it might affect your currency's value or cause capital to flow in or out of your country. E.g. - Singapore prioritizes maintaining stable exchange rate for its currency and allows free capital movement for foreign. It achieves this by managing floating exchange rate system, giving some control over monetary policy and sets it in response to external factors.
  

• If you prioritize monetary policy autonomy and exchange rate stability, you have to restrict free capital movement. Otherwise, investors might move their money in and out of your country based on interest rate differentials, making it hard to control your currency's value. E.g. - China has a strict control over its monetary policy, allowing central banks to act depending on the local employment and inflation. On top of that it had pegged his currency against US to maintain exchange rate stability. But this led to limitation in capital movement, as large outflows to US dollar can disrupt the rates.
  

• If you prioritize free capital movement and monetary policy autonomy, you have to accept that your exchange rate might be volatile because you're not actively managing it. E.g. - US is one of the good examples for this. It prioritizes free capital movement as it is one of the pillars for a ever growing economy. Secondly, since bubbles, it has maintained monetary policy autonomy, which led to, when US sneezes the world catches a cough. But this results in US dollar volatility, which we witnessed extensively post covid till today.