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Policy Trilemma in India: Exchange Rate Stability, Independent Monetary Policy and Capital Account Openness

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  • Majumder Sayantan Bandhu

    (Department of Economics, Sambhunath College, Birbhum, Labpur, West Bengal 731303, India)

  • Nag Ranjanendra Narayan

    (Department of Economics, St. Xavier’s College, Kolkata, West Bengal, India)

Abstract

This paper aims to investigate the situation of policy trilemma in India. Analysing the quarterly data from 1991 to 2015, we find that though the trilemma constraint is binding in the long run, there is ample evidence of short-run deviations from the constraint. Intervention in the foreign exchange market by the Reserve bank of India has successfully helped to relax this constraint. The policy mix has changed over this period – the degree of capital account openness has gradually increased, mainly at the cost of exchange rate stability. We further examine the determinants and the macroeconomic effects of the trilemma policy configuration. We find that the trilemma efficiency depends on the financial stress, financial development, intervention by the Central bank and the liquidity in the economy. Higher monetary policy independence helps to reduce the inflation rate while exchange rate stability and capital account openness are associated with the higher growth rate and the larger output gap.

Suggested Citation

  • Majumder Sayantan Bandhu & Nag Ranjanendra Narayan, 2017. "Policy Trilemma in India: Exchange Rate Stability, Independent Monetary Policy and Capital Account Openness," Global Economy Journal, De Gruyter, vol. 17(3), pages 1-13, September.
    • Handle: RePEc:bpj:glecon:v:17:y:2017:i:3:p:13:n:2
    DOI: 10.1515/gej-2017-0012
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    Cited by:

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    2. Ramandeep Kaur, 2019. "Sensitivity of Macroeconomic Policy Goals to Trilemma and Quadrelimma Choices," Asian Development Policy Review, Asian Economic and Social Society, vol. 7(4), pages 219-238, December.

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    More about this item

    Keywords

    capital account openness; exchange rate stability; impossible trinity; monetary independence;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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