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Hong Kong wants a stable exchange rate with respect to the dollar, and allows free flow...

Hong Kong wants a stable exchange rate with respect to the dollar, and allows free flow of capital to and from the US. Based on the theory of the impossible trinity, what does Hong Kong have to give up and why?Explain your answer

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Answer #1

Before answering this question let us understand the three components of the impossible trinity.

- fixed exchange rate

- free flow of capital

-an independednt monetay policy

It is immpossible to attain all three. Since hongkong wants the first two components then they need to give up the third one that is the independent monetary policy.

It is so because a domestic interest rate that is different from the world int rate would undermine the stable exchange rate due to appreciation or depreciation effect on the domestic currency. Hnece it is not possible to maintain an independent monetary policy.

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