Politics Graduate Students at the University of California, Santa Cruz
The Mundell-Fleming approach is a macroeconomic model that was developed to show the relationship between factors contributing to balance of payments. This model illustrates the tensions involved in an international political economy based on the integration of ostensibly sovereign individual units. The approach is commonly cited as the primary way to what is known as the Impossible Trinity (also referred to as the unholy trinity, the policy trinity, The Mundell-Fleming trinity, The Trilemma, and so on). Briefly, the Impossible Trinity states that it is impossible for a state to achieve all three of the following policy goals at one time, and the state must choose two: an autonomous monetary policy, capital mobility (financial integration), and a stable exchange rate. As Cohen (2017) explains, this principle complicates the policy choices a state has available for responding to a deficit balance of payments, which occurs when a country imports more capital, goods, and services than it exports. This entry briefly discussed each side of the Impossible Trinity before turning to an examination of their dynamics.
The ability for capital (particularly financial capital) to move across borders (i.e. capital mobility) has been widely regarded as a primary characteristic of the modern international political economy since the late 1970s. As Frieden (1991) notes, this mobility has been seen as undermining or contravening national policy, especially as it relates to monetary policy. Monetary policy, according to Cohen (2017) refers to control, by a central bank, of the money supply and of interest rates, which determine the rate of return on capital. Thus, an autonomous monetary policy entails that the state, typically by way of a central bank, can effectively make decisions concerning the amount of money within an economy and the interest rate without external constraint. Cohen’s analysis draws on previous work (Cohen 2006) on monetary power wherein he argues that monetary power allows a state to minimize the costs of adjusting its balance of payments through various policy options. Finally, a stable exchange rate is typically achieved through a pegged exchange rate regime, which entails a state controlling the supply of both foreign and domestic currency. To achieve a set exchange rate, a state can buy or sell amounts of either the foreign or domestic currency.
It is in this final consideration of what a state must do to achieve a fixed exchange rate under conditions of capital mobility that we see the trade-offs with an autonomous monetary policy, particularly in terms of controlling the supply of money. As Cohen (2017), Frieden (1991), and Aizenman (2010) explain, if a state increases the supply of money, this will create a downward pressure on domestic interest rates, which will cause capital to shift from investment in domestic bonds to higher yielding foreign bonds. This increased demand for foreign currencies to purchase foreign bonds provides a dilemma for the central bank, which must interfere in the currency market to maintain a stable exchange rate: the bank must sell its reserve of foreign currency, in order to maintain the exchange rate, and buys back the domestic money it created in the first stage of the process. Thus, as these authors explain, maintaining a fixed exchange rate with capital mobility entails giving up monetary autonomy. The same logic can be applied across the Impossible Trinity.
Empirically, Aizenman (2010) argues that multiple historical financial crises can be explained by attempts to achieve all three sides of the Impossible Trinity: the 1994 Mexican peso crisis, the 1997 Asian financial crisis, and the 2001 Argentinean financial collapse. Interestingly, Aizenman (2013) argues that due to the significant costs of deleveraging crises, which are associated with recessions, the Trilemma framework should be updated as a Quadrilemma with the inclusion of financial stability.
Notably, the Impossible Trinity can be used to further justify Grosfoguel’s pessimism of the futility of nation-level liberation struggles. The Impossible Trinity appears to indicate that the ability for a single nation-state to remain integrated into the international policy economy while retaining autonomy over important aspects of domestic governance is limited. Although, Grosfoguel would perhaps argue that it is unrealistic to achieve monetary autonomy, insofar as that monetary autonomy is used towards decolonization, democratization, and social justice.
Bibliography
Aizenman, Joshua. “The Impossible Trinity (aka the Policy Trilemma): The Encyclopedia of Financial Globalization.” Working Paper, No. 666, University of California, Economics Department, Santa Cruz, CA, 2010.
Aizenman, Joshua. “The Impossible Trinity: From the Policy Trilemma to the Policy Quadrilemma.” Global Journal of Economics 2, no. 1 (2013).
Cohen, Benjamin. “The IPE of Money Revisited.” Review of International Political Economy, 2016.
Frieden, Jeffry. Invested Interests: The Politics of National Economic Policies in a World of Global Finance. International Organization, 1991.
Grosfoguel, Ramón. “Decolonizing Post-Colonial Studies and Paradigms of Political Economy: Transmodernity, Decolonial Thinking, and Global Coloniality.” Transmodernity 1, no. 1 (2011): 1–36.