Possibility of A Dilemma
In the modern world, given the growth of trade in goods and services and the fast pace of financial innovation, it is possible that capital controls can often be evaded. In addition, capital controls introduce numerous distortions. Hence, there are few important countries with an effective system of capital controls, though by early 2010 there has been a movement among economists, policy makers and the International Monetary Fund back in favour of limited use. Lacking effective control on the free movement of capital, the Impossible Trinity asserts that a country has to choose between reducing currency volatility and running a stabilising monetary policy: it cannot do both. As stated by Paul Krugman in 1999:
| “ | The point is that you can't have it all: A country must pick two out of three. It can fix its exchange rate without emasculating its central bank, but only by maintaining controls on capital flows (like China today); it can leave capital movement free but retain monetary autonomy, but only by letting the exchange rate fluctuate (like Britain – or Canada); or it can choose to leave capital free and stabilize the currency, but only by abandoning any ability to adjust interest rates to fight inflation or recession (like Argentina today,). | ” |
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