Estimation of the Effects of Macroeconomic Variables on the Impossible Trinity

Abstract

The examination of exchange rate management, interest rate, and capital market openness is one of the topics under discussion in macroeconomic policies. The assumption in maintaining equilibrium among these three policies is that any change in one of these policies requires an appropriate change in the combination of the other two policies, and there is always an equilibrium among them. The selection of three indicators; exchange rate stability, monetary policy independence, and financial market openness, is well known as the Mundell-Fleming model or the Impossible trinity. The current study explores the common determinants of exchange rate stability, monetary policy independence, and financial market openness using the panel data from a period of 2001 to 2020. Initially, using economic and structural principles, the common determinants of the impossible trinity policy are identified, then parameter estimation is carried out using the SUR model. Finally, it is examined how deviations from the impossible trinity assumption create a political pressure that may lead to a crisis unless policymakers adjust a proper combination compatible with it.

Keywords

• exchange rate stability
• financial market openness
• impossible trinity
• monetary policy independence
• sur