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Independent Monetary Policy: Impossible Trinity Essay

1374 words - 6 pages

One of the most problematic issue in economy is refers to ’’ İmpossible Trinity’ ’,which means that only two out of three choices can be applicable. This options are called : a fixed exchange rate, free capital mobility and an independent monetary policy as we show above figure . That is; It is less likely to possible to have 3 options at the same time. A country can apply a fixed exchange rate which enables capital flows automatically because of running open economy and so a country cannot maintain an independent monetary policy.
Helene Rey states that It is only way to provide independent monetary policy is to have free capital flows ,which leads to have floating exchange ...view middle of the document...

Furthermore; Risk aversion ,uncertainty and credit growth are conversely correlated with each other. Leverage growth and VIX have also negative relationship with each other except that Latin America,CEE and Africa. Furthermore; ıf risk premium is small,this will create the credit boom. Therefore asset prices will also rise, which causes a massive gap between the lending and credit. To summary; high level of VIX is related with low level of capital inflows and outflows, lower credit creation, lower leverage and lower asset price. Finally Helene Rey ,in this article, believe that a country cannot maintain a monetary independence and floating exchange rate regime at the same regime. Developed centered countries are the most important reason for this situation because a country’s exchange rate regime is based on centered countries’ exchange rate. Centered countries determine the monetary policy actions and others follow the such a countries.That is; it shapes the financial cycle globally, which also shapes credit flows and growth, leverages. Free capital mobility and monetary independence can be applicable at the same time but flexible exchange rate regime has to be maintained. Helene Rey suggest some policies should be applied to overcome dilemma .In order to deal with the dilemma a well thought combination of aggressive stress testing and tougher leverage ratios, capital controls as a substitute for macro prudential measures should be provided.
In the article called ‘’ The Trilemma in History’’ written by Maurice Obstfeld, Jay C Shambaugh, Alan M. Taylor focused on exchange stability, monetary independence, and capital market openness. Trilemma will appear with a open economies which has three desirable objectives; stabilizing exchange rate, enjoying free capital mobility and engaging in a monetary policy. A country in an open economy have to choose two out of the three objectives but it is important to decide which one should be modified. This is refers to ‘’Trilemma’’. Before the explainin some issues in this paper, I ‘m going to mention about gold standard and Bretton Wood system. A gold standard refers to a country’s currency and monetary system are based on fixed gold reserves. Also Bretton Wood system is including international aggrements which has been improved during the end of the world war II. Gold standard has fixed rates, free capital mobility and so limited monetary independence. Bretton Wood system can maintain monetary autonomy Since exchange rate is fixed and adjustable , it constraint capital mobility. Such an eras are differs from current era in terms of policies of exchange rate regime.Under gold standard regime; rapid transmission of interest rate and fixed rate episodes are positively correlated with each other. In the Bretton woods era, fixed exchange rate may not limit domestic interest rate and clear capital controls highly. However; There are negative relationship increased interest rate...

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