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Tuesday, October 23, 2007
SummaryWe had a mini-economics discussion within the study group today on the Theory of Impossible Trinity. Although I wrote in my MAS essay for Prelims that the trinity states the impossibiliy of having simultaneously free capital movement, a fixed exchange rate and fixed interest rates, a more accurate way to put it would actually entail a country having simultaneously
1) a fixed exchange rate,
2) free capital movement and
3) an independent monetary policy.
Independent monetary policy meaning the ability to control manipulate interest rates and money supply, something I didn't think of at the start.
Haha for the sake of poor me and my slow thoughts, some elaboration here.
When a country fixes its exchange rate and allows free capital movement, hot money inflow and outflow would be dictated by how attractive it is to place the money in the country. Let's take Singapore for an example, should we try to raise our interest rates, hot money would flow in. Supply of loanable funds increases and hence interest rates fall. Let's say we try our best to fix interest rates at the high level we want (it could be to curb overheating and the like), since we have free capital movement, the continual increase in demand for Sing dollars in the forex market would price (think exchange rate) for Sing dollars. Of course this is not so clearly defined in the real world. Singapore's exchange rate is no clearly fixed but instead fluctuates within a policy band.
Then, when a country fixes its exchange rate and interest rates, for example China, it is incapable of achieving free capital movement. China's gradual rise in interest rates (as a side, China is interesting as it raises interest rates by a step of 0.27 percentage points instead of the usual 0.25) would attract hot money. Should interest rates remain high, as mentioned above, there would be upward pressure on China's exchange rate (think the big hu-ha about it being undervalued right now). Hence, China has to place restrictions on capital movement.
Then when a country fixes it's interest rate and allows for free capital movement, as mentioned above again, exchange rate would neccessarily be up to the whims and fancies of the investing public.
Thus the theory of the impossible trinity states that countries can only control two out of the three at one time. Not that difficult to understand isn't it? I wonder what the discussion was about right from the start. Haha, they were hard at work before I even went there. Hmmm...
Anyway, Junxin said something quite insightful today. The smarter you are and the more you read, the less you get to think for yourself. Reminds me of what whao blogged about waayyy back when he mentioned that sometimes our notes are too good, and this discourages us from making notes ourselves. So, it's actually not so much how smart you are that makes you unable to think. But the amount you read and the diversity of the viewpoints you know about. Given the amount that we know already, upon meeting any circumstances we are often then able to apply what Mr Economist 1 said, or Mr Politician 2 advocated. This would then erode our own mental capacity. Interesting interesting.
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