MMT and the impossible trinity

There’s generally not a lot of common ground between fans of Robert Mundell (the intellectually respectable face of supply side economics) and those of Modern Monetary Theory. Yet in one very important respect, their ideas are two sides of the same coin.

Mundell got his Nobel Memorial Prize, in large measure, for what’s been called the ‘impossible trinity’, namely that a country can’t have all three of a fixed exchange rate, an independent monetary policy and free capital movement.

Turn that round and it says that, if you are willing to give up one of the three, you can have the other two. If we ignore the idea of controlling capital movements completely (limited controls don’t do the job) the trinity becomes a simple two-way choice: fixed exchange rate or independent monetary policy.

If you are on the gold standard, or part of a monetary union, then you are stuck with a fixed exchange rate, and Mundell’s point is that you can’t have an independent monetary policy. Conversely, if you are a sovereign nation, issuing your own fiat money, and you choose not to defend a fixed exchange rate, you can choose your own monetary policy.

That observation is what gives Modern Monetary Theory its name. Under modern (post-gold standard) conditions, any country with its own currency can choose its own monetary policy.

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