The Impossible Trinity Is Getting the Better of Us

Only when Indian markets mature enough to grant us the luxury of full capital account convertibility and a freely floating rupee will we truly gain monetary policy independence

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In Oscar Wilde's The Importance of Being Earnest, Miss Prism tells her student, Cecily, "You will read your Political Economy in my absence. The chapter on the fall of the Rupee, you may omit. It is somewhat too sensational." This week, serious students of the dismal science, as Economics is known at times, did not have that choice. Rather, a 'sensational' fall of the rupee gave them a rare opportunity to see how an otherwise abstruse economic theory, the 'Impossible Trinity,' plays out in real life. It was a classic case of learning the hard way. But first, what does this theory say? According to it, an economy—or a central bank, to be specific—cannot pursue an independent monetary policy, maintain a fixed exchange rate and have free flows of capital at the same time. It must sacrifice one of these three objectives.