The impossibility of the impossible trinity? The case of Indonesia

The impossible trinity suggests that an economy cannot simultaneously achieve a fixed exchange rate, high capital mobility, and independent monetary policy without abandoning one of these. However, This paper looks at Indonesia’s experiences from the 2009 QE and the 2013 taper tantrum, considering why Indonesian policy-makers were unable to use policies as per the trilemma, and the policy implications of this. There are three possible reasons why Indonesia found it difficult to implement this trilemma policy choice: differing monetary policy objectives, volatile floating exchange rates, and balance sheet effects. The commodity supercycle also plays an exogenous role, unable to be overcome by monetary or exchange rate policy while at the same time impacting fiscal policy, income redistribution, trade balance, and the exchange rate. Overall, this paper argues that monetary policy on its own is likely to be insufficient to manage the economy adequately. Other levers and factors, such as macroprudential policy, fiscal policy, capital flow management, and institutional quality, are critical to make the policy choices more effective.