Understanding the "Impossible Trinity"

According to the recent report, the Reserve Bank India mentioned the appreciation of the currency. Which sparked the debate regarding the ignorance of " Impossible Trinity" by RBI.

There are three things that monetary policy is complicated with. They want to

1. keep the exchange rate stable so that import & export prices don't jump,

2. control over interest rates to encourage the borrowers,

3.free movement of currency across the country.

Problems of Impossible Trinity

But the problem of " Impossible Trinity "arises in the economy. As a country lower its interest

rate investment increases. But this also leads to inflation in the economy because of the exchange drop. Therefore, we can fix the exchange rate & let money flow freely but this leads to losing control over the interest rate. Another alternative is to control the interest rate and exchange rates but the flow of money gets restricted. So the monetary policy authority can achieve any two of the above.

Imports are falling more than export which is resulting in a unbalance in supply and demand in the foreign exchange market, as a result the currency is facing appreciation.which is resulting into inflation.

To control inflation RBI sells the government bonds to bank & reduce the excess money from the system. But RBI is not purchasing government bonds & injecting inflation.

In June, the net purchase of dollars was more than $4 billion. Because of which currency trading the foreign exchange reserve increased by $80 billion since January and reached $540 billion.

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