A country can have at most two of a fixed exchange rate, free capital movement, and independent monetary policy.
Mundell and Fleming's result. The euro shows the trade-off live: members fixed the rate and kept capital mobility, so they gave up independent monetary policy, which is what made the 2010-12 crisis intractable.
In practice
- A country pegs its currency and opens its capital account, then finds it cannot cut rates in a downturn without breaking the peg.
- A firm that fixes internal transfer prices and lets divisions trade freely externally loses control of its own margin policy.
- Further reading
- Wikipedia
- Subject
- Economics & Incentives
- Essay
- The regularities money obeys