Trilemma
Trilemma is a term in economic decision-making theory. Unlike a dilemma, which has two solutions, a trilemma offers three equal solutions to a complex problem. A trilemma suggests that countries have three options from which to choose when making fundamental decisions about managing their international monetary policy agreements. However, the options of the trilemma are conflictual because of mutual exclusivity, which makes only one option of the trilemma achievable at a given time.Trilemma often is synonymous with the "impossible trinity," also called the Mundell-Fleming trilemma. This theory exposes the instability inherent in using the three primary options available to a country when establishing and monitoring its international monetary policy agreements.
Definition: The Trilemma, also known as the Impossible Trinity or the Mundell-Fleming Trilemma, is a term in economic decision theory. It describes the three mutually exclusive choices a country faces when formulating its international monetary policy: fixed exchange rate, independent monetary policy, and free capital movement. Since these three goals cannot be achieved simultaneously, a country must choose two and forgo one.
Origin: The concept of the Trilemma was first introduced by economists Robert Mundell and Marcus Fleming in the 1960s. They discovered that a country cannot simultaneously achieve fixed exchange rates, independent monetary policy, and free capital movement when managing its international monetary policy.
Categories and Characteristics: The three options in the Trilemma are:
- Fixed Exchange Rate: The country intervenes in the foreign exchange market to maintain a stable exchange rate of its currency against foreign currencies.
- Independent Monetary Policy: The country can freely adjust its monetary policy, such as interest rates and money supply, based on domestic economic conditions.
- Free Capital Movement: Capital can move freely between countries without foreign exchange controls.
Specific Cases:
- Case 1: Hong Kong's Linked Exchange Rate System Hong Kong has chosen a fixed exchange rate and free capital movement, forgoing an independent monetary policy. Hong Kong's monetary policy is dominated by the US dollar, with the Hong Kong dollar pegged to the US dollar, maintaining a stable exchange rate.
- Case 2: China's Monetary Policy China has chosen an independent monetary policy and capital controls, forgoing complete free capital movement. China manages capital flows through foreign exchange controls while adjusting its monetary policy based on domestic economic conditions.
Common Questions:
- Why can't all three goals be achieved simultaneously? Because maintaining a fixed exchange rate requires intervention in the foreign exchange market, while an independent monetary policy requires free adjustment of interest rates, which affects the freedom of capital movement.
- How to choose the optimal combination? A country needs to choose the optimal combination based on its economic conditions and policy goals. For example, open economies may prefer free capital movement, while closed economies may focus more on independent monetary policy.
