The well-known Mundell-Fleming “trilemma” states that it is not possible to have all three of the following things: free capital mobility, a fixed exchange rate, and the ability to pursue an independent monetary policy. The trilemma does not say that a flexible exchange rate will always fully insulate domestic economic conditions from external shocks. 1 And, indeed, that is not the case.
We have seen that integration of global capital markets can make for difficult tradeoffs for some economies, whether they have fixed or floating exchange rate regimes. Since the Fed is the central bank of the world’s largest economy and issuer of the world’s most widely used reserve currency, it is to be expected that the Fed’s policy actions will spill over to other economies.