According to the “policy trilemma,” which of the following policy configurations is likely to be unsustainable for a small open economy like Australia? Group of answer choicesCapital controls, autonomous domestic monetary policy, fixed exchange rateCapital controls, autonomous domestic monetary policy, floating exchange rateFree capital mobility, autonomous domestic monetary policy, fixed exchange rateFree capital mobility, autonomous domestic monetary policy, floating exchange rate
Question
According to the “policy trilemma,” which of the following policy configurations is likely to be unsustainable for a small open economy like Australia? Group of answer choicesCapital controls, autonomous domestic monetary policy, fixed exchange rateCapital controls, autonomous domestic monetary policy, floating exchange rateFree capital mobility, autonomous domestic monetary policy, fixed exchange rateFree capital mobility, autonomous domestic monetary policy, floating exchange rate
Solution
According to the "policy trilemma" in international economics, it's impossible for a country to have all three of the following at the same time: a fixed foreign exchange rate, free capital movement (absence of capital controls), and an independent monetary policy.
Given this, the policy configuration that is likely to be unsustainable for a small open economy like Australia is: Free capital mobility, autonomous domestic monetary policy, fixed exchange rate.
This is because if a country has free capital mobility and an independent monetary policy, it cannot also maintain a fixed exchange rate. If it tries to do so, it will be subject to speculative attacks on its currency that can deplete its foreign exchange reserves and potentially lead to a financial crisis.
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