The Impossible trinity: Where does India stand?

Abstract

The Global Financial Crisis of 2008 and the heightened macroeconomic and financial volatility that followed the crisis raised important questions about the current international financial architecture as well as about individual countries' external macroeconomic policies. Policy- makers dealing with the global crisis have been confronted with the 'impossible trinity' or the 'Trilemma', a potent paradigm of open economy macroeconomics asserting that a country may not target the exchange rate, conduct an independent monetary policy and have full financial integration, all at the same time. This issue is highly pertinent for India. A number of challenges have emanated from India's greater integration with the global financial markets during the last two decades, one of which includes managing the policy trade offs under the Trilemma. In this chapter, I present a comprehensive overview of a few empirical studies that have explored the issue of Trilemma in the Indian context. Based on these studies I attempt to analyze how have Indian policy makers dealt with the various trade-offs while managing the Trilemma over the last two decades.