Question

3. The impossible trinity Suppose the government of Iraq is deciding what kind of monetary policy and exchange rate regime to choose. The government wants to ensure stability in international trade and investment by pegging the Iraqi dinar to the U.S. dollar. Which of the following policy choices will achieve this goal? Check all that apply. Controlling the interest rate in the country without imposing restrictions on foreign exchange trading Controlling the interest rate in the country and imposing restrictions on foreign exchange trading Maintaining capital controls with no independent monetary policy

Answer 1

Answer:

Correct Answer is (B)

Explanation:

We look at the objectives the government has in mind to achieve;

- stability in international trade

- stability in investment

Which of the listed policies will achieve these goals?

- the tool here used to control international trade is foreign exchange trading

- the tool used to control investment is interest rate

To achieve stability in these 2 indicators, both tools should be controlled. Thus the monetary policy & exchange rate regime to choose here is:

Controlling the interest rate in the country and imposing restrictions on foreign exchange trading.

Option (C) won't suffice because an independent monetary policy is necessary.