Mundell-Fleming Model
a)Discuss what is meant by the “Impossible Trinity.” Illustrate the concept and show its relevance with real world examples from both developed and he developing nations.
The Impossible Trinity defined
In a world where financial globalisation and market interdependence is ever growing in importance, countries around the world would all want the ideal currency regime. The three sought after attributes of the ideal currency would be exchange rate stability, full financial integration and monetary independence. These three goals identified as the “Impossible Trinity”, meaning that only two of them could be achieved simultaneously thus abandoning the third (Joshi, 2003). The Mundell-Fleming model is fundamental in illustrating this relationship between these three goals.
Exchange rate stability requires a country to have a relationship with other major currencies that is fixed in nature, so that traders and investors could be relatively certain of the foreign value of each currency in the present and near future (Eitemn, Stonehill, & Michael, 2010). The opposite if this is of course a local currency whose value is determined by the market. Full financial integration where there is complete freedom of movement of funds from one country and one currency to another, as opposed to having barriers prohibiting this movement. Monetary independence allows an individual country to set its own national economic policies particularly those pertaining to inflation control, full employment and combating recession. (Eitemn, Stonehill, & Michael, 2010)
As stated above “Impossible Trinity” states that a country may simultaneously choose any two, but not all of the three policy goals this is viewed based on the Mundell-Fleming Model in the context of an open economy an extension of the IS-LM Neo-Keynesian model. (Aizenman, 2011) The theory can be better explained using an example. Imagine a country fixes its exchange rate to the Euro. In order to match the Euro the currency
The Impossible Trinity defined
In a world where financial globalisation and market interdependence is ever growing in importance, countries around the world would all want the ideal currency regime. The three sought after attributes of the ideal currency would be exchange rate stability, full financial integration and monetary independence. These three goals identified as the “Impossible Trinity”, meaning that only two of them could be achieved simultaneously thus abandoning the third (Joshi, 2003). The Mundell-Fleming model is fundamental in illustrating this relationship between these three goals.
Exchange rate stability requires a country to have a relationship with other major currencies that is fixed in nature, so that traders and investors could be relatively certain of the foreign value of each currency in the present and near future (Eitemn, Stonehill, & Michael, 2010). The opposite if this is of course a local currency whose value is determined by the market. Full financial integration where there is complete freedom of movement of funds from one country and one currency to another, as opposed to having barriers prohibiting this movement. Monetary independence allows an individual country to set its own national economic policies particularly those pertaining to inflation control, full employment and combating recession. (Eitemn, Stonehill, & Michael, 2010)
As stated above “Impossible Trinity” states that a country may simultaneously choose any two, but not all of the three policy goals this is viewed based on the Mundell-Fleming Model in the context of an open economy an extension of the IS-LM Neo-Keynesian model. (Aizenman, 2011) The theory can be better explained using an example. Imagine a country fixes its exchange rate to the Euro. In order to match the Euro the currency
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