Answer to Question #115265 in Macroeconomics for Liu Ka Yee

Question

Explain the concept of “The Impossible Trinity”. Use the case of expansionary monetary policy to
illustrate your answer.

Answer 1

The Impossible Trinity is meaning that there isn't open economy which has all three of the following at the same:

1) A fixed foreign exchange rate.

2) Free capital movement

3) An independent monetary policy

The main reason is that the difference in supply of money in different economies is offset by the exchange rate.

If some country (whith free capital movement) changes its monetary policy the supply of money changes too. Without foreign exchange rate control it will take on a new value. Government may control foreign exchange rate, but at the same time it should control capital movement or government go bankrupt. Country may have a fixed foreign exchange rate and free capital movement but cannot define own monetary policy so as not to create a difference in money offers.