Unholy Trinity

The Unholy Trinity is an international economic principle that the policymakers of a country may pursue only two out of three policy directions. The three policy directions are the free movement of capital, an independent monetary policy, and a fixed or pegged exchange rate policy.

Out of the three policy directions, states would most likely wish to pursue an independent monetary policy and exchange rate stability. However, as most governments now know, capital controls are hard to enforce as economic actors are easily able to find ways to evade such restrictions. Furthermore, capital controls discourage foreign economic actors from investing their capital in a country since they may not be able to freely remove their capital in the future. As a result, most governments simply cannot impose workable capital controls, which all but ensures that the free movement of capital is one of the two policy directions that governments will choose.

This servers as the basis for Milton Friedman’s declaration that flexible exchange rates are necessary for free trade, as foreign and domestic investors must be permitted to freely move capital across international borders to satisfy balance of payments and for governments to retain independent monetary policies, especially as an anti-recessionary measure.

Benjamin Cohen argues that although international coordination may solve the problem of the Unholy Trinity with coordinated state action in regard to exchange rates, states are induced by ever-changing incentives to cheat or cooperate on such arrangements in order to further their own short-term policy priorities. Such uncertainty thus makes exchange rate coordination untenable.