International Finance Trilemma
After 2007-2012 global economy recessions, many nations are striving to sustain their economy stability in the efforts of meeting the respective governments and citizens’ fundamental needs. Primarily, Trilemma of international finance hold that a country or nation cannot concurrently peg the exchange rate, maintain the independent monetary policy and permit free financial flows cross-borders (Feenstra & Taylor, 2008). International finance Trilemma states that under no given scenario that a country will enjoy steady foreign exchange rates, capital mobility and monetary policy that is independent. Based on international finance Trilemma, the central bank is often tasked to ensure that the economy is stable through pursuance of the two policies among the articulated three simultaneously.
Thus, international finance Trilemma implies that a nation can pursue one or two policies in an attempt of stabilizing its economy. For instance, assume the global interest rate is 7%, the central bank of a nation attempts to set its home interest rate at 4% that is lower than the global 7%. The implication in the economy will be home currency depreciation pressure as the investors will tend to sell or dispose of the cheap domestic currency in an aspiration to buy high foreign currency (Copeland, 2005). On the other hand, if Central bank may want have free flows of capital and prevents home currency depreciation it can only sell its reserves foreign currency. Based on finance the central bank reserves are limited, through selling of such reserves will deplete them. As a result, the domestic currency will also depreciate simultaneously. Hence, international finance Trilemma’s three objective policies cannot be pursued by the central bank simultaneously. As a result, the central bank has no option than to forgo or apply the ‘opportunity cost approach’ in the three objectives an exempt one policy and adopted two.
Background and Related Work
Literary, there is a long literature of international finance Trilemma in different economic times emphasizing different motives in attempting to keep nation's economy stable. Based on 1963 economist Marcus Fleming introduces the concept of ‘impossible trinity’ in their article in discussing problems encountered in establishing a stable system of international finance. The report primarily articulated fundamental trade-offs between the three goals such as independent monetary policy, fixed foreign exchange as well as capital mobility. Thus, in Mundell-Fleming model of 1963 it stated that a nation with a small economy, cannot achieve all the possible three policy goals simultaneously. Hence, in pursuing any of the two goals a country must always forgo the third goal to enhance the success of the other goal (Obstfeld, Maurice, Shambaugh, & Taylor, 2004).
A British magazine ‘The Economist’ published article series titled ‘uneasy Triangle’ to articulate the concept of Trilemma in 1952. Citing with the magazine, it described Trilemma as a three- cornered triangle that was entirely incompatible with fixed price levels, collective bargaining mobility, and full employment. The magazine’s context articulated that it is impossible to balance or to maintain the stability of the three without sacrificing one of the goals. The paper further expounded on financial Trilemma through the use of deflation-reflation model. If inflation caused as a result of labor militancy as a context of full employment will effectively have a downward pressure on the nation is sterling pound (Editorial, "The Uneasy Triangle, n.d.). Keynes Maynard also anticipated the critical problem that is entirely associated with reconciling fixed prices, full employment and collective bargaining mobility (Keynes, 1936).
Other related work to international finance Trilemma can be cited with Peter Swenson in 1989 in his Trilemmas wage policy. Swenson work articulated the issues encountered by trade unions in attempting to achieve the egalitarian three goals at the same time. It is practically impossible for the trade unions to be able in compressing wages, share effectively VAT and profit expense and increased earnings and finally, maximize jobs simultaneously. Steven Pinker with his social Trilemma in his book ‘The blank slate’ and ‘How the Mind Works’ is another earlier work in international finance Trilemma. Pinker articulated that in the society that we dwell in, it is impractical for it to be simultaneously fair, equal and free in social life. For instance, if the society was free, parents will apparently leave their bulk inheritance to their minor children. If it were fair individuals who toil hard could have accumulated more wealth (casual laborers). Finally, the society can never be equal to different individual start with different levels in life and bestowed with distinct fortunes.
The paper used a research-based evidence model with extensive and intensive analytical analysis of the literature reviews on international finance Trilemma. The report used different modes of collecting data based on the succinct of the much-anticipated of the study of international finance Trilemma. The paper used financial journals, memos together with financial literature books of government publications the entire world. Based that the world is experiencing advancement in technologies the report also employed the use of online sources. Such as scholarly articles, Google books, and other credible SEO to obtain critical data for the project of international finance Trilemma. The rationale for using financial literature books from government publications is that they are detailed and can be used to make a logical conclusion. In addition, the paper intensively employed the use of finance reports from different central banks to increase the succinct of the report in developing an informative, analytical conclusion of the report. Based that international finance Trilemma is a global economy concept, the paper evaluated different central banks’ strategic models of stabilizing their respective economies. Further, the paper analyzed the practicality of international finance Trilemma and it role in a global economy based on different monetary policies that the banks adopt to sustain stable economies.
In a bid for nations to stabilize their respective economies, central banks are not bound to apply many approaches as possible depending on the different economic situations the nation’s faces. However, based on the study, the international finance Trilemma practicalities were events as the central bank can only apply two main options at the time, not all the three (Rym, 2013). Central banks often combine such tasks in monetary stability together with the nation his financial stability. The study finds that international finance Trilemma can be presented as shown in figure 1:
Financial Policies Financial integration
For instance, the report found out that if the central bank decides to employ or adopted the monetary policy as a mechanism to stabilize the nation is economy, there are a fundamental consideration that should be applicable. Such consideration that the central bank should ensured that are in place if it takes monetary policy mechanism it should be able to control both supply and demand for money. Under the monetary policy, the banks should also monitor the lending rates and the economy’s interests in other commercial banks of the country (Borio, & PitiDisyatat, 2009). The other model that the central bank can use to stabilize the country’s economy is to maintain fixed exchange rates in the country. The exchange rates might not be stable, but they must not be volatile because the country’s investors often use the exchange rates in making investment decisions. Based on capital mobility and the financial policies the stable exchange rates will effectively breakdown (Obstfeld et al., 2005). Despite the fact that international finance Trilemma models only allow the application of two out the three policies i.e. exchange rate, maintain the independent monetary policy and financial mobility (Floyd, 2010).
Based on the research conducted it is prudent that nations need alternative international finance Trilemma solutions in the efforts to govern international banking system to be proactive. As a result, international finance Trilemma should be precise and consistency in the nature of operation worldwide to reduce the global economy trade-offs. International Financial authorities and central banks should necessitate same operation terrain in the global front (Melvin, Michael, & Norrbin. 2012). National economist and policymakers were found to attempt to achieve simultaneously the three stability goals, thus making international finance Trilemma practicalities impossible in the long run. Such efforts ended up causing the country’s capital mobility to volatile in the economy. Economically, the study found that capital mobility permits nations to invest adequately abroad thus increasing the nation’s GDP. The rationale to this from the research articulates that capital mobility collectively brings together nation’s resources and expertise thus encouraging foreign investors. Such mechanisms such as monetary policy are employed in that nation as a tool in stabilizing the country’s economy. Logically, the paper expounds on the monetary policy in looking at money supply and demand with the nation’s central bank’s interest rates. For instance, if there is a recession in a country’s economy, the country’s money value is reduced due to a high central bank and commercial banks’ interest rates will be overheated.
Other results from the study can be articulated in the country’s currency exchanging rates in international finance Trilemma should maintain stability. Based on the true nature of economy such exchange rates may be driven by speculations equations in the efforts to maintain it stability. For instance, United States may decide to invest abroad in international finance Trilemma in its economy. Such that it can maintain its price stability, its international mutual fund and adequately maintain full employment by using its Federal monetary policies Reserve set. The study articulates that a global economy requires an economic stability system for better economic integration and globalization process in the global economy.
The current accumulation of international reserves by the emerging quasi-pegged foreign exchange rates that are often considered as inexplicable, the world needs a stable international finance Trilemma. The problem of international financial Trilemma can be solved by the national financial authorities, and central banks could function in the same terrain. Based that currently international finance Trilemma are working under harmonization model. The report articulated that it will be better if a reform model should be established that national financial authorities must adhere and cooperate. The rationale used for the paper to reach such extreme resolutions is due to faced with international finance Trilemma nations have joint venture at stake in the international front. Thus, they are should have a sense of responsibility for establishing a stable international financial Trilemma in the world.
Ayadi, Rym. 2013. Monetary Policies. Palgrave Macmillan. http://lib.myilibrary.com?id=559984.
Borio, C. E. V., and PitiDisyatat. 2009. Unconventional monetary policies: an appraisal . Basel: Bank for International Settlements, Monetary and Economic Dept.
Copeland, Laurence S. 2005. Exchange rates and international finance . Harlow, England: Financial Times/Prentice Hall.
Editorial, "The Uneasy Triangle. (n.d.). The Economist.
Floyd, John E. 2010. Interest rates, exchange rates and world monetary policy . Berlin: Springer. http://public.eblib.com/choice/publicfullrecord.aspx?p=510697.
Keynes, J. M. (1936). The general theory of employment, interest and money. New York: Harcourt, Brace.
Melvin, Michael, and Stefan C. Norrbin. 2012. International money and finance . Boston: Elsevier Press. http://www.sciencedirect.com/science/book/9780123852472.
Obstfeld, Maurice, Shambaugh, J., & Taylor, A. (2004). The Trilemma in History: Tradeoffs among Exchange Rates, Monetary Policies, and Capital Mobility. (Obstfeld, Maurice; Shambaugh: Tradeoffs among Exchange Rates, Monetary Policies, and Capital Mobility. Center for International and Development Economics Research.