Question

What is the “impossibility trinity” in foreign exchange markets?

Discuss with reference to the foreign exchange regime in Hong Kong.

Answer 1

Ans. Impossibility trinity also known as trilemma is an economic decision making theory. This theory suggests that while making the fundamental decisions about the monetary policy agreement a company have three options to choose from which are mutually exclusive that means only one option can be achievable at a time.

These three options are:

1) Setting of fixed currency exchange rate (fixed foreign exchange rate)

2) Free capital movement

3) Independent or Autonomous monetary policy

It is called impossible because it is impossible to achieve all of them at a same time.

In reference to foreign exchange regime in Hong Kong, hong kong known to be the freest economy in the world. It chooses fixed currency exchange rate and allows the free movement of capital. Thus, it excludes the independent monetary policy option. It have done so because a stable exchange rate helps in maintaining the economic and social stability of Hong Kong.