Abstract
This paper aims to investigate the situation of policy trilemma in India. Analysing the quarterly data from 1991 to 2015, we find that though the trilemma constraint is binding in the long run, there is ample evidence of short-run deviations from the constraint. Intervention in the foreign exchange market by the Reserve bank of India has successfully helped to relax this constraint. The policy mix has changed over this period – the degree of capital account openness has gradually increased, mainly at the cost of exchange rate stability. We further examine the determinants and the macroeconomic effects of the trilemma policy configuration. We find that the trilemma efficiency depends on the financial stress, financial development, intervention by the Central bank and the liquidity in the economy. Higher monetary policy independence helps to reduce the inflation rate while exchange rate stability and capital account openness are associated with the higher growth rate and the larger output gap.
