What is the currency of "Transnistria?

Does the economic concept of an impossible trinity apply when governments attempt to fight a currency appreciation?

• The concept of the impossible trinity is partially predicated upon a centrals bank inability to purchase unlimited amounts of their own currency / sell foreign currency given that they have finite foreign reserves. From Wikipedia-- Economists Michael C. Burda and Charles Wyplosz provide an illustration of what can happen if a nation tries to pursue all three goals at once. To start with they posit a nation with a fixed exchange rate at equilibrium with respect to capital flows as its monetary policy is aligned with the international market. However the nation then adopts an expansionary monetary policy to try to stimulate its domestic economy. This involves an increase of the monetary supply, and a fall of the domestically available interest rate. Because the internationally available interest rate adjusted for forex differences has not changed, market participants are able to make a profit by borrowing in the country's currency and then lending abroad – a form of Carry trade. With no capital control market players will do this en masse. The trade will involve selling the borrowed currency on the forex market in order to acquire foreign currency to lend abroad – this tends to cause the price of the nations currency to drop due to the sudden extra supply. Because the nation has a fixed exchange rate, it must defend its currency and will sell its reserves to buy its currency back. But unless the monetary policy is changed back, the international markets will invariably continue until the governments foreign exchange reserves are exhausted,[6] causing the currency to devalue, thus breaking one of the three goals and also enriching market players at the expense of the government that tried to break the impossible trinity.[7] However, does this concept apply in the other state of the world, where they are trying to prevent a currency appreciation? They are no longer constrained by their foreign reserves, as they can print as much money as they want (in order to buy foreign / sell domestic currency) to achieve a depreciation of the currency.

• Answer:

  Yes, the impossible trinity applies to both undervalued and overvalued currencies, provided that there is a fixed exchange rate. This is a very good question. I haven't encountered this in the literature but having thought about it a bit it seems to be that it exists both in theory and in practice, although the practical implications are less dramatic than currency crises. I'm sure a critical discussion in the literature will exist. The three parts of the impossible trinity are: Independent . Perfect Capital Mobility. Fixed . is partially correct - the can always respond to appreciation pressure by 'printing' more money (it probably doesn't do much actual printing, but simply electronically credits depositors' accounts). However, he seems to neglect the fact that if the central bank has a reaction function which causes it to dislike and the undervaluing of the currency is causing inflationary pressures, then eventually it will be forced to let the currency appreciate. In other words, in keeping an undervalued currency consistent with perfect capital mobility, the central bank may have to give up its control over monetary policy. Extremely loose monetary policy would be needed (as 's answer points out). This, combined with an undervalued currency, will lead to strong inflationary pressures. However the central bank cannot use a tightening of monetary policy to combat inflation because it is too busy expanding the money supply to maintain the low exchange rate. An interesting example is - in order to maintain low/stable inflation with its currency manipulation policy, it has to impose capital controls.