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What is Economic Trilemma?

What is economic trilemma?

The economic trilemma, also known as the impossible trinity, is a concept in international economics that describes the trade-off between a country's three policy goals:

  1. Exchange rate stability: This refers to a country's ability to maintain the value of its currency within a certain range, which can help promote confidence in the economy and support trade and investment.

  2. Free capital movement: This refers to the ability of individuals and businesses to easily move their money in and out of a country, which can promote economic growth and development.

  3. Independent monetary policy: This refers to a country's ability to control its own money supply and interest rates, which can help promote economic stability and growth.

The economic trilemma is called an "impossible trinity" because a country can only achieve two of these goals at any given time. Attempting to achieve all three can lead to economic instability and other negative consequences. As a result, countries must carefully balance these policy goals in order to achieve the best outcomes for their economies.

For example, consider a country that wants to maintain a stable exchange rate, allow free capital movement, and have an independent monetary policy. In order to maintain a stable exchange rate, the country's central bank may need to intervene in the foreign exchange market by buying or selling its own currency in order to keep its value within a certain range. This intervention, however, can limit the central bank's ability to independently set monetary policy, as its actions in the foreign exchange market can impact the money supply and interest rates.

On the other hand, if the country allows free capital movement, it may be difficult to maintain a stable exchange rate. This is because free capital movement allows investors to easily move their money in and out of the country, which can lead to large swings in demand for the country's currency. This can make it difficult for the central bank to maintain a stable exchange rate, as it may need to constantly intervene in the foreign exchange market to keep the currency's value within a certain range.

Additionally, if the country wants to have an independent monetary policy, it may need to limit capital movement in order to avoid destabilizing the economy. This is because a free flow of capital can lead to large influxes of money into the economy, which can lead to inflation and other economic imbalances. In order to avoid this, the country may need to impose controls on capital movement, such as requiring investors to obtain government approval before moving their money in or out of the country.

Overall, the economic trilemma illustrates the trade-offs that countries must make when it comes to exchange rate stability, free capital movement, and independent monetary policy. While a country may want to achieve all three of these goals, it is only possible to achieve two at any given time. This means that countries must carefully weigh the benefits and costs of each policy goal in order to determine the optimal balance for their economy.

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