One of the things we learned about in class is the trilemma which states that if a country pegs its exchange rate to a base country’s currency and allows the free flow of capital in and out of the country, then it follows that the country’s interest rate will be the same as that of the base country . In other words, a nation that has a pegged exchange rate loses the ability to determine its own course on monetary policy.
The pandemic has created both demand and supply shocks that are huge and negative. In countries with floating exchange rates, central banks have literally thrown the book at the problem, using every possible tool of monetary policy to support the economy through these rough times. But what about countries that have a fixed exchange rate? They have NO ability to use traditional “interest rate” policies, which leaves them incredibly vulnerable. How have such countries navigated the last 18 months? Is their economic performance worse than those countries whose currencies float? If not, how come?
