IDEAS home Printed from https://ideas.repec.org/a/asi/adprev/v10y2022i3p200-225id4561.html
   My bibliography  Save this article

Impossible Trinity in a Small Open Economy: A State–Space Model Simulation

Author

Listed:
  • Guna Raj Bhatta
  • Rabindra Nepal
  • Kankesu Jayanthakumaran
  • Charles Harvie

Abstract

Should monetary policy independence be maintained when the exchange rate is fixed under closed capital account conditions in a small open economy? In this study, we simulate the impossible trinity condition during 1989 to 2019 on the Nepalese economy that restricts capital flows and fixes the exchange rate with India. We modify the traditional Taylor rule based on the monetary policy reaction function to characterize Nepal's economic conditions more closely. The state–space model simulation shows that the policy trilemma does not hold in Nepal, such that the model can predict interest rate when the weight for domestic conditions is assigned at a substantially lower level. Therefore, the existing policy mix may need to be revisited to maintain monetary policy independence. Nepal might consider devaluing its currency to neutralize the adverse effects of the negative risk premium and ameliorate the real exchange rate appreciation in the short run and explore alternative arrangements in the long run.

Suggested Citation

  • Guna Raj Bhatta & Rabindra Nepal & Kankesu Jayanthakumaran & Charles Harvie, 2022. "Impossible Trinity in a Small Open Economy: A State–Space Model Simulation," Asian Development Policy Review, Asian Economic and Social Society, vol. 10(3), pages 200-225.
    • Handle: RePEc:asi:adprev:v:10:y:2022:i:3:p:200-225:id:4561
    as

    Download full text from publisher

    File URL: https://archive.aessweb.com/index.php/5008/article/view/4561/7159
    Download Restriction: no
    ---><---

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:asi:adprev:v:10:y:2022:i:3:p:200-225:id:4561. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Robert Allen (email available below). General contact details of provider: https://archive.aessweb.com/index.php/5008/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.