What Mundell’s impossible trinity lacks: The risk of exchange rate instability related to the variability of capital flows in both OECD and emerging countries

Mundell’s impossible trinity shows that only two of the following three objectives can be pursued : A fixed exchange rate; Free international capital movement; An “independent” monetary policy, i.e. with a domestic objective (generally price stability). Both emerging and OECD countries have usually opt ed for free capital movement ( the absence of capital controls) and an independent monetary policy (inflation targeting) and therefore flexible exchange rates. But this then exposed the limit of Mundell’s impossible trinity, in both OECD and emerging countries. The chosen arrangement leads to excessive variability in international capital flows (in response to divergences between countries’ monetary policies and due to the free movement of capital) and, as a result, excessive variability in exchange rates that is destabilising for economies. This calls for the use of capital controls (emerging countries) and the inclusion of the exchange rate in monetary policy objectives (OECD).