The Impossible Trinity (also known as the Inconsistent Trinity, Triangle of Impossibility or Unholy Trinity) is the hypothesis in international economics that it is impossible to have all three of the following at the same time:
- A fixed exchange rate
- Free capital movement
- An independent monetary policy.
The point is that you can't have it all: A country must pick two out of three. It can fix its exchange rate without emasculating its central bank, but only by maintaining controls on capital flows (like China today); it can leave capital movement free but retain monetary autonomy, but only by letting the exchange rate fluctuate (like Britain--or Canada); or it can choose to leave capital free and stabilize the currency, but only by abandoning any ability to adjust interest rates to fight inflation or recession (like Argentina today, or for that matter most of Europe).
– Paul Krugman[1]
The formal model for this hypothesis is the Mundell-Fleming model developed in the 1960s by Robert Mundell and Marcus Fleming. The idea of the impossible trinity went from theoretical curiosity to becoming the foundation of open economy macroeconomics in the 1980s, by which time capital controls had broken down in many countries, and conflicts were visible between pegged exchange rates and monetary policy autonomy. While one version of the impossible trinity is focused on the extreme case — with a perfectly fixed exchange rate and a perfectly open capital account, a country has absolutely no autonomous monetary policy — the real world has thrown up repeated examples where the capital controls are loosened, resulting in greater exchange rate rigidity and less monetary-policy autonomy. In the modern world, given the growth of trade in goods and services, capital controls are easily evaded. In addition, capital controls introduce numerous distortions. Hence, there is virtually no important country which has an effective system of capital control. Under these conditions, the Impossible Trinity asserts that a country has to choose between reducing currency volatility and running a stabilising monetary policy: it cannot do both.
References
- ^ Paul Krugman (1999). "O Canada: A neglected nation gets its Nobel", Slate, October 19 1999.
