Question

Assess the impossible trinity concept in the context of the fixed/flexible exchange rate regimes.

(PLEASE ANSWER THOROUGHLY AND IN DEPTH)

Answer 1

ANS: Impossible trinity concept is also called as Trilemma. It is a concept in international economics that it is impossible to have all the following at the same level of time -

• Fixed Foreign Exchange rate - It is also called as Pegged exchange rate, in which value of one currency is tied with the another currency. A fixed exchange rate is firmly set by the monetary authorities, whereas floating exchange rate depends upon the market demand & supply. Through pegged exchange rates, a country is able to gain competative trading advantage by protecting its economic interest & exposed themselves to high level of export.
• Free capital Movement - It means capital is allowed to move freely from one country to another country regardless of discrimination based on nationality. It provides easy & seamless movement of capital.
• Independent monetary policy - It is only possible when the exchange rates are flexible. More flexible the exchange rate, larger the scope of central bank to set the policies independently. Fexible rates are dependent upon the market demand & supply.