Empirical Evidence on ‘Impossible Trinity Hypothesis’: A case of Pakistan

Abstract

The impossible trinity hypothesis is a well-known empirically tested hypothesis for developed as well as developing countries. However, the empirical validity of this hypothesis has not been investigated specifically for Pakistan, which has experienced regime changes in exchange rate and capital account over the course of the years. This study is an attempt to empirically validate the impossible trinity hypothesis (trilemma) in the case of Pakistan, following the Aizenman, Chinn and Ito (ACI, 2008) approach. This includes calculating the trilemma indices and investigating their evolution over the period of 1973-2019. The results from the regression with the full sample data reveals that trilemma is binding in Pakistan. The results show that policy priority is given to exchange rate stabilization while less emphasis is placed on financial openness.