Background:
- The impossible trinity, or the trilemma, refers to the idea that an economy cannot pursue independent monetary policy, maintain a fixed exchange rate, and allow the free flow of capital across its borders at the same time.
- According to economists, any economy can choose to pursue only two out of the three policy options noted above simultaneously in the long-run.
- The idea was proposed independently by Canadian economist Robert Mundell and British economist Marcus Fleming in the early 1960s.
A difficult choice
- Practically speaking, in today’s world in which capital is largely free to move across borders with ease, the choice before policymakers is between maintaining a fixed exchange rate and pursuing independent monetary policy.
- If policymakers choose to peg or maintain the value of their currency at a certain level against a foreign currency, this decision will limit the kind of monetary policy they can adopt in the long-run.
- This is because the decision to peg the exchange value of the currency can tie down the hands of central bankers when it comes to their domestic monetary policy stance.
- For example, if a country’s policymakers want their currency to appreciate, or become stronger, against foreign currencies, they cannot achieve this goal and maintain the external strength of the currency over a considerable period of time without adopting a tight domestic monetary policy stance which will weaken domestic demand.
- This is because loose monetary policy will put pressure on the country’s currency to depreciate in value. Thus, policymakers will have to choose between maintaining the strength of their currency and upholding nominal demand in the domestic economy which is heavily influenced by monetary policy.
- On the other hand, if policymakers of a country choose to pursue independent monetary policy, they may not be able to maintain the foreign exchange value of their currency at a desired peg.
- This is because the kind of monetary policy adopted by an economy’s central bank invariably influences the exchange value of its currency against foreign currencies.
- For example, if a country’s central bank adopts easy monetary policy with the aim of boosting domestic demand, this will naturally cause the value of its currency to depreciate against foreign currencies if foreign central banks adopt tighter monetary policy.
- If so, it would be difficult to maintain the foreign exchange value of the currency unless the central bank holds sufficient foreign exchange reserves to prop up the currency’s value.
- In fact, over the long-run, it may be impossible for the country’s central bank to defend the foreign exchange value of its currency as it may soon run out of the foreign exchange reserves necessary to prop up the value of its currency.
Restricting movement
- It should be noted that only a few decades ago, when strict capital controls were used to regulate the flow of capital across borders, economies could choose to pursue independent monetary policy and still hope to maintain a certain exchange value against foreign currencies.
- Whenever monetary policy exerted an undesirable effect on the currency’s exchange rate, policymakers could impose controls on the flow of capital to maintain the foreign exchange value of their currency.
- For example, if a country’s central bank decides that it wants to adopt easy monetary policy that could weaken the exchange value of its currency, it could impose capital controls to stop the depreciation of its currency. It should be noted, however, that capital controls come at a price. They hinder the free flow of capital and adversely affect economic growth by preventing the efficient allocation of scarce resources across the globe.
Current trilemma
- The trilemma has come under focus recently as the U.S. Federal Reserve has been raising interest rates to fight rising prices.
- In a world where capital is largely free to move across borders, this has led many investors to pull money out of the rest of the world and rush to the U.S. in search of higher yields, thus putting pressure on many currencies such as the Indian rupee.
- In fact, even developed markets like Japan and the Eurozone have seen their currencies depreciate significantly against the U.S. dollar.
- Notably Japan, in contrast to other national central banks, has been unwilling to tighten its monetary policy in response to rising interest rates in the U.S.
- This has caused the Japanese currency, the Yen, to depreciate about 25% against the U.S. dollar so far this year.
- In essence, the Bank of Japan has allowed its currency to fall, preferring to maintain control over its domestic monetary policy.
- The Reserve Bank of India may also face the dilemma of choosing between maintaining the value of the rupee and holding on to its monetary policy independence.
- As the U.S. Federal Reserve has raised interest rates, there has been increasing pressure on the rupee, which has depreciated almost 10% against the U.S. dollar this year.
- For now, the RBI seems to be fairly happy tightening its monetary policy stance to defend the rupee as it also helps to rein in price rise which has been a concern even in India.
- But if the U.S. Federal Reserve continues to tighten its policy stance even after price rise in India is reined in by the RBI, then the Indian central bank may have to choose between defending the rupee and upholding domestic demand.
Recent Posts
- In the Large States category (overall), Chhattisgarh ranks 1st, followed by Odisha and Telangana, whereas, towards the bottom are Maharashtra at 16th, Assam at 17th and Gujarat at 18th. Gujarat is one State that has seen startling performance ranking 5th in the PAI 2021 Index outperforming traditionally good performing States like Andhra Pradesh and Karnataka, but ranks last in terms of Delta
- In the Small States category (overall), Nagaland tops, followed by Mizoram and Tripura. Towards the tail end of the overall Delta ranking is Uttarakhand (9th), Arunachal Pradesh (10th) and Meghalaya (11th). Nagaland despite being a poor performer in the PAI 2021 Index has come out to be the top performer in Delta, similarly, Mizoram’s performance in Delta is also reflected in it’s ranking in the PAI 2021 Index
- In terms of Equity, in the Large States category, Chhattisgarh has the best Delta rate on Equity indicators, this is also reflected in the performance of Chhattisgarh in the Equity Pillar where it ranks 4th. Following Chhattisgarh is Odisha ranking 2nd in Delta-Equity ranking, but ranks 17th in the Equity Pillar of PAI 2021. Telangana ranks 3rd in Delta-Equity ranking even though it is not a top performer in this Pillar in the overall PAI 2021 Index. Jharkhand (16th), Uttar Pradesh (17th) and Assam (18th) rank at the bottom with Uttar Pradesh’s performance in line with the PAI 2021 Index
- Odisha and Nagaland have shown the best year-on-year improvement under 12 Key Development indicators.
- In the 60:40 division States, the top three performers are Kerala, Goa and Tamil Nadu and, the bottom three performers are Uttar Pradesh, Jharkhand and Bihar.
- In the 90:10 division States, the top three performers were Himachal Pradesh, Sikkim and Mizoram; and, the bottom three performers are Manipur, Assam and Meghalaya.
- Among the 60:40 division States, Orissa, Chhattisgarh and Madhya Pradesh are the top three performers and Tamil Nadu, Telangana and Delhi appear as the bottom three performers.
- Among the 90:10 division States, the top three performers are Manipur, Arunachal Pradesh and Nagaland; and, the bottom three performers are Jammu and Kashmir, Uttarakhand and Himachal Pradesh
- Among the 60:40 division States, Goa, West Bengal and Delhi appear as the top three performers and Andhra Pradesh, Telangana and Bihar appear as the bottom three performers.
- Among the 90:10 division States, Mizoram, Himachal Pradesh and Tripura were the top three performers and Jammu & Kashmir, Nagaland and Arunachal Pradesh were the bottom three performers
- West Bengal, Bihar and Tamil Nadu were the top three States amongst the 60:40 division States; while Haryana, Punjab and Rajasthan appeared as the bottom three performers
- In the case of 90:10 division States, Mizoram, Assam and Tripura were the top three performers and Nagaland, Jammu & Kashmir and Uttarakhand featured as the bottom three
- Among the 60:40 division States, the top three performers are Kerala, Andhra Pradesh and Orissa and the bottom three performers are Madhya Pradesh, Jharkhand and Goa
- In the 90:10 division States, the top three performers are Mizoram, Sikkim and Nagaland and the bottom three performers are Manipur and Assam
In a diverse country like India, where each State is socially, culturally, economically, and politically distinct, measuring Governance becomes increasingly tricky. The Public Affairs Index (PAI 2021) is a scientifically rigorous, data-based framework that measures the quality of governance at the Sub-national level and ranks the States and Union Territories (UTs) of India on a Composite Index (CI).
States are classified into two categories – Large and Small – using population as the criteria.
In PAI 2021, PAC defined three significant pillars that embody Governance – Growth, Equity, and Sustainability. Each of the three Pillars is circumscribed by five governance praxis Themes.
The themes include – Voice and Accountability, Government Effectiveness, Rule of Law, Regulatory Quality and Control of Corruption.
At the bottom of the pyramid, 43 component indicators are mapped to 14 Sustainable Development Goals (SDGs) that are relevant to the States and UTs.
This forms the foundation of the conceptual framework of PAI 2021. The choice of the 43 indicators that go into the calculation of the CI were dictated by the objective of uncovering the complexity and multidimensional character of development governance
The Equity Principle
The Equity Pillar of the PAI 2021 Index analyses the inclusiveness impact at the Sub-national level in the country; inclusiveness in terms of the welfare of a society that depends primarily on establishing that all people feel that they have a say in the governance and are not excluded from the mainstream policy framework.
This requires all individuals and communities, but particularly the most vulnerable, to have an opportunity to improve or maintain their wellbeing. This chapter of PAI 2021 reflects the performance of States and UTs during the pandemic and questions the governance infrastructure in the country, analysing the effectiveness of schemes and the general livelihood of the people in terms of Equity.
Growth and its Discontents
Growth in its multidimensional form encompasses the essence of access to and the availability and optimal utilisation of resources. By resources, PAI 2021 refer to human resources, infrastructure and the budgetary allocations. Capacity building of an economy cannot take place if all the key players of growth do not drive development. The multiplier effects of better health care, improved educational outcomes, increased capital accumulation and lower unemployment levels contribute magnificently in the growth and development of the States.
The Pursuit Of Sustainability
The Sustainability Pillar analyses the access to and usage of resources that has an impact on environment, economy and humankind. The Pillar subsumes two themes and uses seven indicators to measure the effectiveness of government efforts with regards to Sustainability.
The Curious Case Of The Delta
The Delta Analysis presents the results on the State performance on year-on-year improvement. The rankings are measured as the Delta value over the last five to 10 years of data available for 12 Key Development Indicators (KDI). In PAI 2021, 12 indicators across the three Pillars of Equity (five indicators), Growth (five indicators) and Sustainability (two indicators). These KDIs are the outcome indicators crucial to assess Human Development. The Performance in the Delta Analysis is then compared to the Overall PAI 2021 Index.
Key Findings:-
In the Scheme of Things
The Scheme Analysis adds an additional dimension to ranking of the States on their governance. It attempts to complement the Governance Model by trying to understand the developmental activities undertaken by State Governments in the form of schemes. It also tries to understand whether better performance of States in schemes reflect in better governance.
The Centrally Sponsored schemes that were analysed are National Health Mission (NHM), Umbrella Integrated Child Development Services scheme (ICDS), Mahatma Gandh National Rural Employment Guarantee Scheme (MGNREGS), Samagra Shiksha Abhiyan (SmSA) and MidDay Meal Scheme (MDMS).
National Health Mission (NHM)
INTEGRATED CHILD DEVELOPMENT SERVICES (ICDS)
MID- DAY MEAL SCHEME (MDMS)
SAMAGRA SHIKSHA ABHIYAN (SMSA)
MAHATMA GANDHI NATIONAL RURAL EMPLOYMENT GUARANTEE SCHEME (MGNREGS)